ENVIRONMENTAL COST ACCOUNTING FOR CAPITAL BUDGETINGinfohouse.p2ric.org/ref/03/02262.pdf · CAPITAL BUDGETING PROCESS ... Who makes initial decision to place an environmental project

OMB # 2070 0138

Prepared for:

Pollution Prevention DivisionOffice of Pollution Prevention and Toxics

Office of Prevention, Pesticides, and Toxic SubstancesU.S. Environmental Protection Agency

By:

Tellus Institute11 Arlington St.

Boston, MA 02116-3411

Allen L. White, Ph.D.

Deborah E. Savage, Ph.D.Julia Brody, Ph.D.Dmitri Cavander

Lori Lach

September 1995

ENVIRONMENTAL COSTACCOUNTING FOR CAPITAL

BUDGETING:

A BENCHMARK SURVEY OFMANAGEMENT ACCOUNTANTS

TABLE OF CONTENTS

EXECUTIVE SUMMARY

INTRODUCTION................................................................................................................................................ 1

THE MANAGEMENT ACCOUNTANT PERSPECTIVE................................................................................ 4

RESEARCH DESIGN......................................................................................................................................... 5

RESPONDENT PROFILE.................................................................................................................................. 8

CAPITAL BUDGETING PROCESS.................................................................................................................12

TRENDS IN CAPITAL BUDGETING......................................................................................................................17 TRACKING ENVIRONMENTAL COSTS................................................................................................................18

THE COST INVENTORY..............................................................................................................20

HOW WIDE IS THE NET? ..................................................................................................................................20 ARE ENVIRONMENTAL COSTS QUANTIFIED? ...................................................................................................25 SUPERFUND LIABILITY: MAJOR OR MINOR PLAYER?.....................................................................................27

COST ALLOCATION........................................................................................................................................33

FINANCIAL INDICATORS: THE BOTTOM LINE.......................................................................................39

CONCLUSIONS.................................................................................................................................................47

REFERENCES

APPENDIX A ADVANCE AND FOLLOW UP LETTERS TO SURVEY RESPONDENTS

APPENDIX B SURVEY QUESTIONNAIRE

TABLES AND FIGURES

TABLES

Table 1. Contacts with survey sample.........................................................................................5Table 2. Follow-up results .........................................................................................................6Table 3. Terms firms use to categorize capital projects............................................................14Table 4. Who develops cost estimates for environmental projects?...........................................17Table 5. Costs normally considered in financial analysis...........................................................23

Table 6. Cost items for which specific values are calculated.....................................................27Table 7. Initial assignment of costs..........................................................................................35

FIGURES

Figure 1. Respondent’s product line (by SIC code).....................................................................8Figure 2. Respondent’s position at firm......................................................................................9Figure 3. Number of employees worldwide................................................................................9Figure 4. Most recent annual sales............................................................................................10Figure 5. Annual corporate budget...........................................................................................11Figure 6. Level at which capital budgeting occurs....................................................................12Figure 7. Limit on discretionary capital spending....................................................................13Figure 8. Who makes initial decision to place an environmental project...................................15

Figure 9. Level at which environmental costs tracked...............................................................19Figure 10. Level at which environmental costs tracked.............................................................19Figure 11. Cost boundaries......................................................................................................21Figure 12. How Superfund is handled......................................................................................30Figure 13. Factors accounted for by liability assessment method..............................................31Figure 14. Basis for allocating costs to product/processes from overhead.................................37Figure 15. Sources of cost information when assigning costs to products/processes..................38Figure 16. Financial indicators used for screening projects.......................................................40Figure 17. Financial indicators used for full project justification..............................................41

Figure 18. Payback period used, payback users only................................................................42Figure 19. IRR required for approval, IRR users only..............................................................43Figure 20. Time horizon for NPV, NPV users only..................................................................44Figure 21. IRR time horizon used, IRR users only....................................................................44Figure 22. Approval thresholds for environmental projects.......................................................45

ACKNOWLEDGEMENTS

This study was funded under Cooperative Agreement # 821580-01 between Tellus Instituteand the U.S. Environmental Protection Agency (EPA).

This report was made possible by the U.S. EPA’s Environmental Accounting Project, acomponent of its Design for the Environment Program. The Environmental Accounting Project worksto encourage and motivate businesses to understand the full spectrum of environmental costs and toincorporate them into decision-making. For information on this project, its publications and activities,please contact the Pollution Prevention Information Clearinghouse at (202) 260-1023.

We gratefully acknowledge the management and technical support of Marty Spitzer of the EPAAdministrator’s Pollution Prevention Policy Staff, who served as EPA's Project Manager for most ofthis study. Holly Elwood and Susan McLaughlin of the Environmental Accounting Project, guided theproject through its final stages. The study was made possible by Social Science Research Funds fromEPA’s Office of Research and Development. In addition, under the guidance of Harriet Tregoning,EPA’s Office of Policy, Planning, and Evaluation, Waste Policy Branch provided funding for theSuperfund portion of the study. We received extremely valuable review of the survey instrument andsample design from Carl Koch and Jim Daley, also at EPA.

Julian Freedman, Research Director at the Institute of Management Accountants (IMA),arranged for IMA collaboration on this project, including access to IMA membership lists andpermission for mention of IMA in our advance communications with survey respondents. Thisassistance is but one example of his continuing efforts to bring environmental accounting issues to theattention of the profession.

Review of early drafts of the survey instrument was coordinated and/or provided by GeorgeNagle and Allan Rosenfeld of Bristol-Myers Squibb, Scott Noesen of Dow Chemical, WalterDickerson of Polaroid Corporation, and Tom Klammer of the University of North Texas. Weappreciate the time and insights of these individuals in helping to revise and streamline the surveyquestionnaire. We also thank Daryl Ditz of the World Resources Institute, Marc Epstein of theStanford Business School, and George Nagle of Bristol-Myers Squibb for their comments on the draftfinal report.

A special thanks for the early inspiration for Tellus Institute's work in environmentalaccounting, dating to 1989, is due to Dick MacClean, now with Arizona Public Service Corporation,and Matt Polsky, of the New Jersey Department of Environmental Protection, Division of Science andResearch.

Finally, we appreciate the cooperation of all survey respondents for their participation in thisstudy. In times of burgeoning information requests to the business community, it is easy to ignore yetanother mailing asking for time and data. For those management accountants who saw value in thesurvey and responded to our inquiry with care and precision, we appreciate your collaboration.

Any errors in analysis and interpretation of data remain the sole responsibility of the authors.

EXECUTIVE SUMMARY

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Environmental Cost Accounting for Capital Budgeting

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nvironmental cost accounting --- the identification, compilation, analysis, use, and reporting ofenvironmental cost information -- has emerged as one of the foremost items on the agenda ofbusiness in the 1990s. The reasons for this phenomenon are many and varied, and originate bothwithin and outside the firm.

For internal decision-making, environmental costs impinge upon many facets of businessoperations. For legal staff, meeting the Securities and Exchange Commission (SEC) requirementsfor disclosure of environmental liabilities (most notably remediation costs) demands regular andsystematic appraisal of the anticipated costs "reasonably likely to have a material effect" on thefinancial condition of the firm. For the accounting staff, compliance with Financial AccountingStandard (FAS) No. 5 on contingency costs creates the same need for tracking and reportingenvironmental liabilities that affect the balance sheet of the firm. And for financial staffresponsible for monitoring and maximizing the value of the firm, disclosure of any kind ofenvironmental information -- pollution levels or their cost repercussions -- may influence the stockmarket's perception of the firm's value.

Though the formal requirements of the SEC and Financial Accounting Standards Board(FASB) have attracted much attention, they are by no means the only reason for firms to put inplace workable environmental costing systems. For product managers, properly inventoried andallocated environmental costs may make the difference between a profitable and unprofitableproduct line. For the environmental or production engineer, a rigorous accounting ofenvironmental compliance costs is integral to identifying and prioritizing process improvements.For the plant manager facing an increasingly competitive domestic and global marketplace ofproducts with low profit margins, effective control of environmental costs may be critical toensuring long-term viability. And, at the highest management level, the chief executive committedto continuous improvement should have a working knowledge of environmental costs tobenchmark a firm's performance against its competitors and industry as a whole.

On the external front, pressures are mounting to encourage or require tracking anddisclosure of various types of environmental costs. The debate over how to improve nationalincome accounts to account for use and depletion of natural assets has spilled into the corporatearena in the form of pronouncements on "full-cost accounting" (FCA). Though definitions vary,the vision is common -- creating accounting systems that will allow both firms and theirstakeholders (investors, customers, environmental organizations, host communities) a clearperspective on the total environmental effects of a company or facility. The emergence of life-cycle analysis, including its monetary component life-cycle costing (or "impact valuation"), is areflection of this movement toward greater public accountability of the environmentalconsequences of product manufacture, use, and disposal. Though few firms have yet to take stepsin the direction of reporting such cost information, pressures to do so will continue to grow aspart of the broader movement toward higher standards for corporate environmental managementsystems, public accountability, and accounting.

PURPOSE AND SCOPE

A Benchmark Survey of Management Accountants

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The purpose of this study is to benchmark current corporate environmental costaccounting practices as they are applied to the capital budgeting decisions in U.S. manufacturingfirms. It seeks to provide business managers and government agencies with an understanding ofhow firms are integrating environmental cost considerations into decisions about environmentalinvestments. Such an understanding can assist firms in comparing their practices with industryaverages and in prioritizing improvements. For government agencies, a profile of environmentalaccounting in relation to environmental investments can help target technical assistance and policyinitiatives as well pinpoint those areas of cost accounting where innovation is most visible or,alternatively, most lagging.

In this study, “environmental investments” is broadly defined, encompassing any capitalproject -- compliance or non-compliance -- that has as a major (though not necessarily exclusive)objective, the control, reduction, or prevention of pollution. Though all types of investments andother business decisions certainly stand to benefit from improved environmental accounting, afocus on environmental investments offers the most accessible "window" into current corporatepractices. This is the case because most corporate environmental accounting innovations thus farhave been linked to, and driven by, decisions surrounding environmental projects. Thus, the studyfindings are confined to one application of environmental cost accounting as an internal decisionsupport tool. The costs of interest are all those which are "internal" (versus external or social) innature, that is, costs that are material to the firm's decisions about if, when, and how much of itscapital resources ought to be allocated to specific environmental investments.

The survey targeted corporate management accountants in U.S. industrial firms based onthe judgment that the accounting function in business, if properly informed and mobilized, canplay a key role in advancing environmental accounting practices in business organizations. This isnot to say that management accountants currently play such a catalyst role. Indeed, to date,environmental staff probably have been the prime movers in rethinking how accounting systemscan better serve the firms' long-range environmental management objectives. At the same time,the accounting profession remains dominated by financial accountants whose responsibility islargely information-gathering to support external reporting to shareholders and regulators.Advances in the management accounting community have occurred, but progress has been slowerin revamping cost accounting systems to provide relevant information to modern businessdecision-making. Nonetheless, besides being an excellent source of benchmarking information forthe business and government audiences, the opportunity is at hand to activate the managementaccountant profession in support of improved environmental accounting.

The survey sample was selected from a list of approximately 5,000 members of theInstitute of Management Accountants (IMA) using two criteria: (1) employment in themanufacturing sector (SICs 20-39) and (2) self-identification as responsible for planning andbudget or cost functions within their respective firms.

Of the estimated 787 eligible respondents, we received 149 completed questionnaires, aresponse rate of 19%. Though the survey sample was randomly drawn, respondents weredecidedly weighted toward larger firms. Forty-two percent have 5000 employees or more

RESPONDENTS


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worldwide, whereas only 8% have fewer than 200 employees. Moreover, 49% report annualworldwide sales of over $500 million and only 3% report sales under $10 million.

How do firms structure and manage their capital budgeting processes, specifically withrespect to environmental projects? Are such projects given special treatment in the form ofearmarked funds or budget caps? What business functions regularly participate in the capitalbudgeting process? Major findings from the survey indicate that:

• The single most common structure, reported by 30% of all respondents, is budgetingat three business levels -- plant, division, and corporate. Corporate only, divisiononly, and plant only represented 17%, 16%, and 16%, respectively.

• Discretionary spending for capital projects is a feature often associated with firms

with multiple plants. In total, 72% of respondents report some level of discretionaryspending allowed at individual facilities, ranging from $5000-$100,000.

• The vast majority of respondents (86%) report a single capital funding pool for all

capital projects, environmental or otherwise. • Product/operations, environmental, and finance/accounting personnel are the most

routine contributors to costing environmental projects, followed by consultants andpurchasing staff.

Moving from questions of capital budgeting in general to the question of environmentalcosting practices:

• 71% of respondents reported that their company tracks some environmental costs ona company-wide basis.

• Among those who track environmental costs on a company-wide basis, 64%

reported tracking at plant level, 63% at the corporate level, and 44% at thedivisional level. These figures reflect multiple responses (i.e., tracking may beoccurring at more than one level within the firm).

CAPITAL BUDGETING PROCESS

TRACKING COSTS


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What internal costs are included in environmental project financial evaluation? And towhat extent are such costs quantified in the project justification process, as opposed to handled inqualitative fashion only?

• Environmental costs most often considered in project financial evaluation are thosethat are the most tangible and quantifiable, for example: on-site air/wastewater/hazardous waste testing/monitoring, on-site wastewater pretreatment/treatment/disposal, on-site hazardous waste pre-treatment/treatment/disposal, off-site hazard-ous waste transport, and waste manifesting are considered by more than 60% of therespondents.

• Environmental costs least frequently considered in project financial evaluation

include: environmental fines and penalties, corporate image, insurance costs,personal injury claims, marketable by-products, natural resources damage costs,legal staff time, and sales of environmentally friendly/green products. Based onearlier studies, these are also the costs generally perceived as less tangible,contingent, and difficult to quantify.

To what extent, then, are "considered" costs also quantified? Among those costs normallyconsidered in project financial evaluation, which are assigned a "specific dollar value" for costs orsavings?

• In general, firms who consider a specific cost item are inclined to take the next stepand quantify such costs. For example, while only 55% report considering insurancecosts, 84% of those respondents quantify these costs. This pattern generally holdstrue across all cost items.

• For two-thirds of all environmental costs, 70% of firms who report they consider

such costs also quantify them during project financial evaluation.

Among all environmental costs on the minds of corporate managers, one deserves specialattention -- Superfund liability. We asked respondents if and how Superfund liability affectsvarious aspects of internal management decision-making in the area of capital budgeting.

• Among all respondents, only 32% indicated they consider Superfund in capitalenvironmental project evaluation.

• Among those who do consider Superfund, 33% assign a specific dollar value, 23%

do not, and 44% combine qualitative and quantitative evaluation methods. This

THE COST INVENTORY: HOW WIDE IS THE NET?

ARE ENVIRONMENTAL COSTS QUANTIFIED?

SUPERFUND LIABILITY: MAJOR OR MINOR PLAYER?


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suggests that somewhere between only 7-14% of all respondents regularly quantifySuperfund liability during project financial evaluation.

• If liability is considered in any form, it generally appears after financial evaluation is

complete and a project is brought to upper management for final review andapproval.

• For the few firms who consider a project’s effect on hazardous waste (“Superfund”)

liability in preparing an appropriations request for an environmental project, 74% usean assessment method developed internally.

• By a substantial margin, the most frequently cited hurdle (58%) to quantifying

liability is difficulty in estimating if liability costs will occur. Following this is thedifficulty in estimating the magnitude of costs (45%) and when liability will occur(29%).

• Contrary to conventional wisdom that legal concerns play a key role in excluding

liability from investment decisions, remarkably few identified "If I quantify, I may besubject to toxic torts" (5%) and "If I quantify, I have to disclose to the SEC" (3%)as barriers to quantifying liability.

• • A total of 61% of survey respondents indicated that Superfund liability was either

very important (27%) or somewhat important (34%) in determining priorities forenvironmental projects, suggesting that the general appreciation of liabilityavoidance well exceeds concrete steps to quantify it.

When firms incur environmental costs, not all processes and products are equallyresponsible for cost generation. Even in modest-sized manufacturing firms with two or threeproduction lines, the costs of licensing, monitoring, waste storage, emissions controls,environmental staff time, off-site disposal, insurance, future regulatory compliance, and evenliability are not driven equally by each production line. Some process lines may be morehazardous materials-intensive, generate more emissions per unit output, require more frequent andintensive inspection and monitoring, and generate greater quantities of waste requiring off-sitedisposal. Similarly, particular processes, or products, may cause a disproportionate share of costsassociated with training and reporting to government agencies, or give rise to risks that may resultin higher insurance costs or risks of future personal or property damages. In short, when it comesto environmental costs, not all processes and products are created equal.

To obtain a glimpse of current practices, we asked respondents to describe their currentpractices in cost allocation across a range of 17 environmental costs. For each cost item,respondents were asked to check whether the initial cost assignment was: always to overhead,usually to overhead, usually to product/process, or always to product/process.

COST ALLOCATION


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• For every cost item, "always to overhead" is the most frequent response. Virtually allcosts fall in the 55-75% response range; that is, well over half of respondents reportinitially assigning environmental costs always to overhead accounts.

• Costs most often initially assigned to overhead -- from licensing/permitting to

insurance costs -- are those most typically associated with central staff functions orplant-, division-, or corporate-wide overhead costs, e.g., legal, environmental, andtraining staff activities.

• The pattern of diminishing frequency from overhead to product/process assignment

holds steadily for all entries, regardless of how tangible costs are. • 58% of those who initially assign costs to an overhead account later reallocate to a

product or process. This translates into about 44% of all survey respondents. • Labor hours (55%) and production volume (53%) are by far the most common bases

for allocating overhead costs back to products/processes, followed by materials use(27%) and square footage of facility space (24%).

• Financial/accounting systems data, mentioned by 51% of respondents, is the most

frequent source of environmental cost information. This is followed by purchasing,production/operation logs, engineering estimates, and materials tracking information.

Improving the cost inventory and cost allocation methods are major steps toward greaterbalance and rigor in evaluating environmental projects. Two other variables that can play adecisive role in determining whether projects survive the intense competition for scarce capitalresources are the choice of project financial indicators and the related issue of analysis timehorizons.

In addition to their less tangible and contingent nature, many environmental costs andsavings materialize only in the mid- and long-term. In contrast to costs of activities such as on-site air and hazardous waste testing, monitoring, handling, and manifesting, other costs (orsavings/revenues) linked to corporate image, liability, and green product sales are by nature thosewith longer-term time horizons. In the case of future compliance costs, the very term impliescosts that will materialize only some years into the future. Thus, if any of these costs form part ofthe cost/benefit calculation of a proposed environmental project, an analytical method that isinsensitive to mid- and long-term cost and revenue streams will be incapable of capturing thelong-term profitability of the proposed project. Pollution prevention projects are especiallyvulnerable to this shortcoming. This is the case because many rely on product redesign, processmodification, and materials substitution that may be capital intensive but yield attractive returnsbeginning 3-5 years after the initial capital outlay.

FINANCIAL INDICATORS: THE BOTTOM LINE


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• 74% of respondents indicated they perform "a less detailed/informal screening" ofenvironmental projects prior to a detailed financial analysis.

• For those firms that perform informal screenings, Return on Investment (ROI)

(25%) and Payback (25%) are the most commonly used financial indicators. Elevenpercent of respondents report use of qualitative methods.

• For full project justification, ROI at 24% is the leading quantitative indicator,

followed by Internal Rate of Return (IRR) at 18%. However, for 27% ofrespondents, the single most frequent response to this question, is that their"evaluation is qualitative only." This strikingly high figure may be explained by thetendency of some respondents to interpret environmental projects as compliance-driven or "must-do," thereby not warranting the resources to develop a full financialevaluation.

• Among all respondents, 56% indicate no "standard hurdle rate, or threshold" is

required before approving an environmental project. Moreover, 57% report equalhurdle rates for environmental and non-environmental projects, 36% report thathurdle rates are lower for environmental investments.

• Among those respondents who use Payback at any stage of project justification, 1-2

years is by far the most common (50%) hurdle rate required for project approval.For IRR users (48% of respondents), hurdle rates reported are 10-19%, followed by20-30% (25% of respondents) and greater than 30% (18% of respondents).

Among the many internal business functions served by rigorous, disaggregatedenvironmental cost information, capital budgeting for environmental projects is one of theprincipal beneficiaries. Accounting systems to identify, compile, analyze, and reportenvironmental cost information in a timely and rigorous fashion are a prerequisite tounderstanding the sources and magnitude of environmental costs in the firm. Only if these costsare understood can managers maintain a clear picture of the true costs of current productionprocesses and products. This, in turn, allows managers to direct attention to opportunities tominimize compliance costs, reduce operating costs, and fully mesh the environmental and financialperformance goals of the organization.

Concerning the key issues of environmental cost inventory and cost allocation methods,the survey suggests that much work remains before business practices provide managers with acomprehensive and transparent look at "true" costs of processes and products. While most firmsquantify the more obvious and measurable environmental costs, substantially fewer have grappledwith those that are less tangible, uncertain, and difficult to quantify. Estimates of environmentalcosts in the range of 3%-20% of facility operational or product line costs as reported by somecompanies may, after a closer look, be substantially understated.

CONCLUSIONS


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Dealing systematically with these types of costs is not new to corporations. In the normalcourse of business, managers regularly look into the future to forecast everything from the priceof oil to consumer demand for a new line of computers. Applying these approaches, includingthose drawn from risk analysis, to estimate less tangible costs would represent a major steptoward characterizing current and future environmental costs.

Cost allocation, too, remains a major challenge. Most firms continue to place mostenvironmental costs initially into overhead accounts. Though some subsequently allocate thesecosts to products or processes, the basis upon which these allocations are made are often ill-conceived, that is, they bear little or no relationship to the activities which are responsible for theircreation. When proper allocation does not occur, managers receive distorted signals regardingthe true costs and benefits of retaining or changing processes and products. Moreover, likeincomplete cost inventories, misallocation of environmental costs stands in the way of effectiveperformance monitoring, product pricing, incentives and rewards systems, and other activitiesessential to maintaining a competitive enterprise.

Upgrading the capital budgeting system through improved environmental accountingsystems is best viewed in the broader context of strategic planning. With multiple forces workingto fuse environmental and financial objectives of the firm, it is critical to exercise an even hand inevaluating the returns to all capital investments, environmental or otherwise. When cost inventoryand cost allocation practices fail to provide a level playing field for all investments, managers areleft without the information they need to make optimal use of limited resources. In particular,those environmental projects with strong pollution prevention content, as well as those with sidebenefits unrelated to environmental improvement per se -- e.g., process optimization and yield,market penetration, corporate image -- are particularly vulnerable to the adverse effects ofincomplete cost information.

While many social benefits may result from improved internal environmental accounting,the case for such improvements may be made purely on the basis of the firm's self-interest. This isthe central message that public policymakers, professional associations, trade associations andstakeholders should deliver to firms seeking to understand and apply environmental accountingtechniques to their capital budgeting processes.


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nvironmental cost accounting --- the identification, compilation, analysis, use, and reportingof environmental cost information -- has emerged as one of the foremost items on the agenda

of business in the 1990s. The reasons for this phenomenon are many and varied, and originateboth within and outside the firm.

For internal decision-making, environmental costs impinge upon many facets of businessoperations. For legal staff, meeting the Securities and Exchange Commission (SEC) requirementsfor disclosure of environmental liabilities (most notably remediation costs) demands regular andsystematic appraisal of the anticipated costs "reasonably likely to have a material effect" on thefinancial condition of the firm (Edwards 1992). For the accounting staff, compliance withFinancial Accounting Standard (FAS) No. 5 on contingency costs creates the same need fortracking and reporting environmental liabilities that affect the balance sheet of the firm. And forfinancial staff responsible for monitoring and maximizing the value of the firm, disclosure of anykind of environmental information -- pollution levels or their cost repercussions -- may influencethe stock market's perception of the firm's value (Freedman 1993).

Though the formal requirements of the SEC and Financial Accounting Standards Board(FASB) have attracted much attention, they are by no means the only reason for firms to put inplace workable environmental costing systems (Ditz, Ranganathan and Banks 1995; Todd 1994).For product managers, properly inventoried and allocated environmental costs may make thedifference between a profitable and unprofitable product line. For the environmental orproduction engineer, a rigorous accounting of environmental compliance costs is integral toidentifying and prioritizing process improvements. For the plant manager facing an increasinglycompetitive domestic and global marketplace of products with low profit margins, effectivecontrol of environmental costs may be critical to ensuring long-term viability. For the personnelofficer seeking to create fair and effective employee incentive and reward programs,environmental costs may be a key ingredient in measuring staff performance. And, at the highestmanagement level, the chief executive committed to continuous improvement should have aworking knowledge of environmental costs to benchmark a firm's performance against itscompetitors and industry as a whole.

On the external front, pressures are mounting to encourage or require tracking anddisclosure of various types of environmental costs. The debate over how to modify nationalincome accounts to incorporate the use and depletion of natural assets (Repetto 1989) has spilledinto the corporate arena in the form of pronouncements about "full-cost accounting" (FCA)(Popoff and Buzzelli 1993). Though definitions vary, the vision is common -- creating accountingsystems that will allow both firms and their stakeholders (investors, customers, environmentalorganizations, host communities) a clear perspective on the total environmental effects of acompany or facility. The emergence of life-cycle analysis, including its monetary component, life-cycle costing (or "impact valuation"), is a reflection of this movement toward greater publicaccountability of the environmental consequences of product manufacture, use, and disposal.

INTRODUCTION

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Though few firms have yet to take steps in the direction of reporting such cost information,pressures to do so will continue to grow as part of the broader movement toward higherstandards for corporate environmental management systems, public accountability (Cascio 1994),and accounting (Gray 1993, Rubenstein 1994).

This study is an effort to better understand current practices in one of the manydimensions of environmental cost accounting -- the use of environmental costs in the capitalbudgeting practices of U.S. firms. Our focus is on benchmarking the way U.S. firms identify,allocate, and analyze environmental costs in the context of evaluating the profitability of potentialenvironmental investments. By environmental investments, we mean any capital project --compliance or non-compliance -- that has as a major objective the control, reduction, or prevention of pollution. Thus, our analysis is confined to one aspect ofenvironmental accounting as an internal decision support tool, where costs are limited to thosegermane to the business functions discussed earlier. This distinction between internal and external(or societal) cost domains is a critical one for preserving the clarity of our study’s scope andimplications (White, Savage, and Shapiro forthcoming).

Our study has a number of predecessors. Earlier investigations of corporate practices inaccounting for liability provide a profile of how firms deal with SEC and FASB requirements todisclose future environmental liability costs (Price Waterhouse 1992). Specific questions focusedon the estimation, accrual, recovery, discounting, and reporting of remediation costs known oranticipated by 523 U.S. companies.

A more recent informal survey of 26 Global Environmental Management Initiative(GEMI) conference attendees (23 representing Environmental, Health, and Safety (EHS)functions within their respective firms) provides a profile of several aspects of environmental costaccounting practices (Bristol-Myers Squibb 1994). This survey focused on topics such asmethods and levels of tracking costs, financial analysis of projects, use of Total Cost Assessment(TCA) techniques (White, Becker, and Goldstein 1991), and management's motives andperceptions of the benefits of environmental cost accounting in general. Though limited to a smallsample, some key findings of this survey are noteworthy:

• environmental costs are most often allocated to overhead accounts (versus to productsor processes);

• compliance-related projects are approved without prior financial analysis; and • management control, both capital and operating, is by far the most frequent reason for

tracking environmental costs.

Promoting the use of environmental cost information in capital budgeting has been thesubject of both federal and state voluntary and regulatory initiatives. EPA's EnvironmentalAccounting Project, one component of its Design for the Environment (DfE) activities, hasviewed capital budgeting as one of the key business activities through which improvedenvironmental accounting practices can foster industrial pollution prevention (US EPA 1995). At


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the state level, New Jersey, Maine, and Washington require firms to use some form ofenvironmental accounting, or TCA, in evaluating pollution prevention investment options.Though each has its own language and requirements, all are aimed at guiding business towardenlarging the inventory of environmental costs and allocating such costs to processes andproducts rather than to pooled overhead accounts. Following this trend, business and non-governmental organizations such as GEMI (GEMI 1994) and the Coalition for EnvironmentallyResponsible Economies (CERES 1995) have identified improved environmental accountingmethods as integral to a firm achieving best practices in evaluating capital investments andestablishing a sound materials management program.

As the recognition for improved environmental accounting gains momentum in business,accounting, and government circles, it is useful to step back and take a systematic look at theperceptions, accomplishments, and plans of various types and sizes of firms. Such benchmarkingcan provide valuable information to companies, trade associations, technical assistance providers,and policymakers to:

• evaluate where U.S. firms as a whole are in various aspects of environmentalaccounting applications in capital budgeting;

• compare current practices across firms of different types and product lines to identify

leading and lagging sectors, and to help business and government assistance programsidentify priorities;

• compare progress in different aspects of environmental accounting as applied to

capital budgeting decisions (e.g. cost inventory, cost allocation methods) as input forfuture professional, federal, and state technical assistance initiatives; and

• assess if and how certain public policies (e.g. Superfund liability) promote or impede

improved environmental accounting practices.

Thus, the purpose of this report is to inform both private and public sector initiativesaimed at solidifying the link between sound environmental accounting and sound capital budgetingfor environmental projects. While improved environmental accounting benefits all types ofinvestment decisions, environmental project analysis is likely to be especially enhanced by morerigorous accounting methods for reasons presented later in this report. Thus, the focus onenvironmental projects offers a convenient “window” on where firms are and where they aregoing in bringing environmental costs more systematically into their budgeting process.


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any business functions contribute to the identification, tracking, analysis, use, andreporting of environmental cost information: the purchasing staff who procure waste

disposal services; the environmental manager who oversees the design and operation of an on-site solvent recovery system; the environmental manager or legal staff who oversee monitoring,permitting, and other compliance activities; the environmental engineer who operates the on-sitewastewater treatment plant; the production engineer who tracks raw material inputs and lossesin a batch operation; and the accountant or financial manager who receives, organizes, andreports cost information to upper management.

Is there a single best source of environmental cost information and practices? Becauseenvironmental costs are so varied, diffuse, and often unrecognized, the answer is generally no,especially for mid- and large-sized companies. Assembling costs for a rigorous profitabilityevaluation of compliance and non-compliance projects may require inputs from environmental,legal, purchasing, operations, facilities management, financial, marketing and accounting staff. Infact, it is probably true that if fewer than three of these staff areas are involved in developing costinformation, it is highly probable that some salient costs (or savings) have been omitted from theproject evaluation. And the more a firm seeks to venture into the area of less tangible costs andsavings --e.g., liability avoidance, future regulatory compliance, corporate image effects,expansion into "green" markets -- the wider the cost "net" must be cast to properly capture andquantify such costs.

For this project, we have chosen to survey corporate management accountants in U.S.industrial firms based on the judgment that the accounting function in business, if properlyinformed and mobilized, can play a key role in advancing environmental accounting practices inbusiness organizations. This is not to say that management accountants currently play such acatalyst role. Indeed, to date, environmental staff probably have been the prime movers inrethinking how accounting systems can better serve the firms' long-range environmentalmanagement objectives. At the same time, the accounting profession remains dominated byfinancial accountants whose responsibility is largely information-gathering to support externalreporting to shareholders and regulators (Gray 1993, Rubenstein 1994). Advances in themanagement accounting community have occurred, but progress has been slower in revampingcost accounting systems to provide relevant information to modern business decision-making(Johnson and Kaplan 1991). Nonetheless, the opportunity is at hand to activate the managementaccountant profession in support of improved environmental accounting (Epstein 1995). To takestrides in that direction requires an understanding of the current knowledge base, practices, andperspectives of the profession and the companies it serves. In this spirit we have chosenmanagement accountants as our targeted population.

THE MANAGEMENT ACCOUNTANT PERSPECTIVE

ΜΜ


5

he survey sample was selected from a list of approximately 5,000 members of the Instituteof Management Accountants (IMA) using two criteria: (1) employment in the

manufacturing sector (SICs 20-39) and (2) self-identification in IMA’s membership form asresponsible for planning and budget or cost functions within their respective firms. The IMAmembership list provides the accountant's name, business, and business address (but no telephonenumber). We randomly selected 1,000 names from this list.

In early January of 1995, we sent an advance letter to potential respondents alerting themto the upcoming survey and explaining the purpose of the research (Appendix A). This letteridentified EPA as the funding agency and IMA as the collaborator in the study. The full survey,together with a pre-stamped return envelope, was sent approximately two weeks later1 (AppendixB).

Follow-up by postcard and telephone was conducted during February. A coding errorresulted in the loss of identifying information for 200 members of the sample, preventing follow-up with this group. Reminder postcards were mailed to the other 800 potential respondents inmid-February. Telephone reminders began the following week. We contacted all those for whomwe were able to obtain a working business phone number. Callers asked respondents to returnthe surveys within five business days. Respondents were contacted in person whenever possible,and voice messages were left when this was not possible. Each phone number where callersreported no answer was tried at least four times. Accountants whose surveys were returned asundeliverable by the post office were excluded from telephone follow-up. A summary of contactswith the survey sample is shown in Table 1.

Table 1. Contacts with Survey Sample

Type of Contact n

Advance letter 1,000Survey with pre-stamped return envelope 1,000Post-card follow-up 800Telephone follow-up 626

The IMA list included many entries that no longer represent an active accountant at thebusiness identified in the list. Sixty surveys were returned as undeliverable, and 10 respondentsinformed us by mail or phone that they are not currently engaged in work relevant to the survey.Telephone follow-up identified additional problematic entries. Information about these entries isuseful in interpreting the response rate for the survey, since it indicates that the survey reached farfewer than the original 1,000 eligible participants.

1 Office of Management and Budget Approval # 2070 0138.

RESEARCH DESIGN

T


6

Because the IMA list did not include telephone numbers, our first task in conductingtelephone follow-up was to identify a telephone number for each accountant's business. We found567 phone numbers using Phonedisc 95, a CD-ROM business phone directory. In an attempt tolocate numbers for businesses not included in the CD-ROM directory, we next called DirectoryAssistance for 160 members of the original sample list. An additional 59 phone numbers wereidentified by this method. Based on this rate of success (37%), we concluded that contactingDirectory Assistance for the remaining 173 companies would not be cost-effective. Businesseswith no phone listing include those that have terminated operations or moved outside the areaserved by their earlier telephone directory. Non-listed businesses also include accountants whowork independently and those who do not have a business telephone number. For businesses thatno longer exist or moved, the mailed survey may not have reached an eligible accountant. Amongthe businesses we did reach by telephone, follow-up calls revealed that 114 accountants in thesample list were no longer at the company identified in the IMA list. For these entries, the mailedsurvey did not reach an eligible accountant. Table 2 summarizes results of follow-up efforts.

Table 2. Follow-Up Results

Outcome n

Survey returned by post office 60Accountant reported he/she not engaged in relevant work 10Accountant no longer at listed business 114No business phone listed in CD-ROM/Directory Assistance 109

Based on follow-up results, we can estimate the number of surveys that eventuallyreached an eligible participant. A conservative estimate assumes that surveys reached aparticipant unless (1) they were returned by the post office or (2) telephone follow-up confirmedthat the accountant was no longer at the IMA business address. Using this assumption, weestimate that the survey reached 816 eligible accountants. If we make the additional assumptionthat the percentage of accountants no longer at the listed business would be similar for the 200businesses with whom we were unable to follow-up, we estimate that 787 surveys reached aneligible accountant. Both of these estimates overstate the number of surveys that reached aneligible accountant, since the substantial percentage of businesses for whom there is no businessphone listing includes those that went out of business or moved some distance, so that theaccountant listed by IMA is presumed no longer eligible for the survey.


7

We received 149 completed questionnaires. Thirty-three accountants declined toparticipate when contacted by telephone. "Too busy" was the most common reason for decliningto participate. Using 787 as a reasonable, and perhaps high, estimate of the number of surveysthat reached an eligible accountant, the survey achieved a response rate of 19%. This participationrate is similar to results for other mail surveys of professional groups.


8

igure 1 depicts the distribution of respondents by SIC code. Nearly half (48%) work forfirms in one of four equipment manufacturing sectors plus miscellaneous manufacturers. We

lumped these five SICs together to control the length of the questionnaire: industrial equipment,electric equipment, transportation equipment, instruments and miscellaneous manufacturing. Theremainder are scattered across the other nine categories, with the heaviest representation inchemicals and petroleum/coal (12%) and metals (12%). Those least represented in the sample areprinting (3%) and rubber/plastics (1%). The former is not surprising since printing firms, thoughlarge in number, are generally small establishments of 30 employees or less. These types of firmsare unlikely to have a full-time accountant responsible for planning and budgeting or costfunctions; our survey sample, on the other hand, focuses on such accountants.

RESPONDENT PROFILE

FF

Figure 1. Respondent's product line (by SIC code)

28, 29: Chemicals, Petroleum/Coal12%

22, 23: Textiles, Apparel6%

27: Printing3%

24, 25, 26: Lumber, Furniture, Paper6%

20, 21: Food, Tobacco8%

30: Rubber/Plastics1%

33, 34: Metals12%

32: Stone/Clay/Glass4%

35-39: Industrial/Electric/Transportation Equipment, Instruments, Miscellaneous

Manufacture48%


9

Respondents are located with almost equal frequency in corporate (32%), divisional(31%) and individual plants (31%) (Figure 2). Slightly less than two-thirds (61%) are registrantswith the Securities and Exchange Commission (SEC). With respect to employees (Figure 3),somewhat under half (42%) have over 5000 employees worldwide, while only 8% have fewerthan 200 employees. The remaining 50% are mid- to mid-large-size enterprises in the 200-999range and 1000-5000 employee range.

Figure 3. Number of employees worldwide

8%

24%26%

42%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

< 200 200 - 999 1000 - 5000 >5000

No. of employees

Per

cent

of c

ompa

nies

Figure 2. Respondent's position at firm

Divisional 31%

Corporate32%Plant

37%


10

Annual sales volume approximately mirrors the employment profile of the respondents(Figure 4). Nearly half have annual worldwide sales greater than $500 million, while only 3%report sales of under $10 million. Using 200 employees and $10 million annual sales as a generalrule for distinguishing small businesses from medium and larger enterprises, our sample is clearlyweighted toward the latter. This, again, is expected given our criteria for inclusion in the sample.Professional management accountants with planning, budgeting, and cost responsibilities are likelyto be affiliated with larger corporate organizations with routinized planning and budgeting cycles,multiple plants and divisions, and complex cost structures requiring dedicated accounting staff formanagement and oversight. And, of course, they also are likely to have the financial and humanresources to devote to completion of a survey questionnaire in comparison to the greater resourceconstraints facing smaller firms.

Figure 4. Most recent annual sales

3

26

22

49

0

10

20

30

40

50

< $10million

$10 -100

million

$101 -$500

million

> $500million

Annual sales

Per

cent

res

pond

ents


11

Finally, annual corporate capital budgets track the pattern of company size reflected insales and employment levels (Figure 5). About half (51%) of the respondents report capitalbudgets greater than $10 million, 89% over $1 million, and only 5% less than $.5 million. Themedium- and large-scale weighting of our sample is again evident.

Figure 5. Annual corporate budget

< $0.5 million5%

$1 - $10 million38%

> $10 million51%

$0.5 - $1 million6%


12

ow do firms structure and manage their capital budgeting process, specifically with respectto environmental projects? Are such projects given special treatment in the form of

earmarked funds or budget caps? What business functions regularly participate in the capitalbudgeting process?

A look at the data (Figure 6) reveals that the single most common combination ofresponses was budgeting at all three levels, a process described by 30% of all respondents.Corporate only, division only, and plant only represented 17%, 16%, and 16% respectively.Based on Tellus’ experience working with firms during the last five years, the prevalence of thistiered-type structure is typical of medium- to large-size firms, wherein initial project identificationand justification begins at the plant level, moves up to divisional or group review (unless a projectis small enough to qualify for discretionary spending at the facility level), and finally is approvedor rejected by corporate management. A number of respondents indicated some variation on thecategory names, e.g., "departmental," "operating unit," and "branch." Interestingly, only onerespondent indicated budgeting by "product line." Among all respondents, virtually all (95%)budget on a regular as opposed to an ad hoc basis, a finding expected for a sample dominated bymid- to large-size manufacturers. Four of the five firms whose budgeting is ad hoc fall within thelower half of firm sizes (p<.05)2 as measured by annual sales.

Figure 6. Level at which capital budgeting occurs

Other3%

Corp, div, & plant30%

Corporate only17%

Division only16%

Plant only16%

Corporate & plant6%

Division & plant5%

Corporate & division 4%

Corp, div, plant, other

3%

Discretionary spending for capital projects is a feature often associated with firms havingmultiple plants. In these instances, plant managers are allowed to spend up to a predetermined 2 Pearson chi square test were used for all statistical analyses at p < .05.

CAPITAL BUDGETING PROCESS

HH


13

fixed amount for projects without the formal justification process and divisional or corporateapproval required for larger expenditures. When asked if such discretion exists, respondentsindicated a wide range of such caps (Figure 7). At the low end, 28% indicated no discretionaryspending whatsoever, or “no limit”; all expenditures, no matter how small, require uppermanagement approval. After this no-limit category, respondents reported in roughly equalfractions (12%-18%) discretionary caps ranging from $5000 to over $100,000.3 Thus, in total,72% report some level of discretionary spending allowed in their firms. As in the case ofbudgeting cycle, and consistent with our expectations, it is the larger firms that give individualplants greater independence in undertaking capital projects with upper management approval (p<.05). For example, 80 percent of firms with annual sales under $10 million indicated noallowance for discretionary spending, whereas only 13% of firms with sales greater than $500million reported such a procedure.

Figure 7. Limit on discretionary capital spending

28

1412

18

12

17

0

5

10

15

20

25

30

35

no limit up to$5000

up to$10,000

up to$50,000

up to$100,000

other

Spending Limit

Per

cent

of r

espo

nden

ts

Firms use a wide range of categories to classify projects as they enter the budget cycle,and category names may be critical (White, Becker, and Goldstein, 1991b). Those bearing an"environmental" tag may be viewed as inherently non-value adding. These projects are seen as

3One respondent reported that the discretionary cap depends on who is the highest ranking plant personnel. Thefigure ranges from $25,000 for a "Director" to $250,000 for an Assistant Vice President and $500,000 for a VicePresident. Another respondent reported that the discretionary cap is variable and depends on plant size.


14

necessary but unprofitable uses of capital and, perhaps, are subject to a lower hurdle rate, if any.Alternatively, a project labeled "profit-adding" or "cost-saving" will be more welcome bymanagement in the course of project justification. It is sometimes the case that a project withstrong environmental content may be automatically labeled "environmental" and escape systematicfinancial analysis even though it may, in fact, yield a competitive rate of return if profitabilityanalysis were performed.

Given a list of 14 project categories, respondents were asked which are used to classifyprojects in their firms (Table 3). At the high end (60% or greater reporting the use of a category)are “cost-saving,” “environmental,” “replacement,” and “expansion.” Among other potentialenvironmentally-related categories, about a third, 32%, use the term “compliance,” 25% use“waste treatment,” 20% use “pollution prevention,” and 17% use “waste reduction.” Thus,overall, “environmental” is by far the most common environmentally-related category, which maybe interpreted as an indication that most firms lump environmental projects of all types into asingle category. Insofar as this is the case, the tendency not to discriminate between differenttypes of environmental projects may cloak important contributions of pollution prevention (P2)and waste reductions to non-environmental objectives such as overall yield enhancement and

product quality, as well as profit-adding and cost-saving.

Table 3. Terms firms use to categorize capital projects

Term Percent who use term

Cost saving 73Environmental 67Expansion of existing operations 64Replacement 64Maintenance 54Expansion into new operations 50Compliance 32General/Administrative 27Waste treatment 25Pollution prevention 20Profit adding 20Waste reduction 17Profit sustaining 13Abandonment 3


15

Which business functions tend to assign environmental projects to individual categories?Among the eight choices available and allowing for one answer only (Figure 8), plantenvironmental staff most often make this critical determination (29%), followed by plantfinance/accounting (12%) and corporate finance/accounting staff (12%). Among those whoresponded "other," a variety of staff functions were named: engineering, plant engineering, capitalplanning committee, division manager, consultants, product/process engineer, corporatemanufacturing, and president. Another 15% report using "no categories.” Thus, after eliminating"other" and "no categories," 55% of respondents indicate “plant environmental” and “plantfinance/accounting” as those responsible for project classification. The pivotal role of these staffin project categorization should make the staff a prime target for initiatives -- originating eitherinternal or external to the firm -- to upgrade and refine the project classification process to avoid

the aforementioned pitfalls in financial analysis.

Are environmental projects, both compliance and non-compliance, accorded a separatecapital budget pool or, alternatively, do they compete with other contending projects for capitalresources? The vast majority of respondents (86%) report a single pool, whereas only 11%report a separate pool for environmental projects and 3% for compliance projects. This is afinding of substantial consequence for pollution prevention projects. It once again reinforces the

Figure 8. Who makes the initial decision to place an environmental project in a particular category?

Divisional finance/accounting

6%

Plant finance/accounting

12%

Plant environmental29%

We do not use categories

15%

Other 12%

Divisional environmental

8%

Corporate finance/accounting

12%

Corporate environmental

6%


16

importance of rigorous cost analysis if P2 projects are to compete effectively, since special set-aside funds are the decided exception and intense competition the rule. Though 94% reportannual environmental project expenditures have either "no set cap" or "vary from year to year,"the general absence of earmarked funds implies an intense annual competition for capitalresources.

In the course of environmental project justification, many staff functions may contribute todeveloping cost information for environmental projects (White, Becker, Goldstein 1991a and1991b). These staff functions may include environmental, operations, accounting, financial,purchasing, and facilities management. As the cost net extends to encompass less tangible longer-term costs, savings, and revenues, other staff functions (e.g., legal and marketing) increasinglybecome important sources of information. In fact, there is a direct correlation between the rigorof cost analysis and the number of staff involved in identifying, compiling, and analyzing costinformation. The more numerous and less tangible project costs are -- a characteristic typical ofmany P2 investments -- the more different staff functions are required to do the job right. Forexample, costs/savings associated with liability avoidance, future regulatory compliance,compliance with future international environmental management systems standards, andpenetration of green product markets -- all may require input from staff not traditionally involvedin the project justification process.

When given seven typical sources of cost information and allowed multiple responses,respondents most often cited product/operations, environmental, and finance/accounting staff asroutine contributors to costing environmental projects (Table 4). Over a third indicatedconsultant (38%) and purchasing (36%) participation, followed by vendors (23%) and legal staff(20%). "Others" included a strong showing by engineering/plant engineering (13 respondents)plus an assortment of single mention of others, including: industrial engineering, facilitiesengineering, corporate engineering, and maintenance. The strong showing of environmental andproduction/operations is not surprising given the state-of-the-art of environmental project costingin general, which heavily emphasizes conventional company costs. As awareness of less tangiblecosts/savings increases, we are likely to see a more active role on the part of staff functions suchas legal and marketing. Finally, the appearance of vendors and consultants, though not surprising,is a reminder that these parties should be included in any initiative aimed at strengthening thecosting methods used by manufacturing firms in evaluating environmental projects.


17

Table 4. Who develops cost estimates for environmental projects?

Department Routinely involved (%)

Production/Operations 65Environmental 64Finance/Accounting 64Consultants 38Purchasing 36Vendors 23Legal 20Other 13

Trends in Capital Budgeting

Are capital budgeting practices in general changing in U.S. manufacturing firms? Are suchpractices following the rapid pace of change in business organizations, change spurred by suchforces as merger and acquisition activity, new product development, and changing environmentalregulations? Are efforts to achieve environmental improvements affecting the way firms managetheir capital resources or, as some observers argue, are past practices and traditional shareholdervalue drivers intact despite pressures to become increasingly "green" (Walley and Whitehead1994)?

When presented with eight potential changes to their firms' capital budgeting practicesduring the last three years, the common answer (60%) was "no change." Raising the discretionarycap on facility-level capital expenditures was a distant second at 17%, which may reflect primarilyan inflation adjustment and not a real dollar increase. Four options explicitly related toenvironmental projects4 were each mentioned by no more than 7% of respondents. Thus, apicture of essentially unchanging capital budgeting practices emerges, at least for the changesidentified in the survey instrument. Of course, this does not preclude the possibility that firms aremaking changes unrelated to those that affect their handling of environmental projects.Notwithstanding this possibility, it appears that capital budgeting practices, at least forenvironmental projects, have remained relatively constant amidst downsizing, re-engineering, andother trends and styles that are reshaping American manufacturing industry (Klammer 1994).

4 Whether the firm stopped or started classifying environmental projects separately from other capital projects, andwhether the firm stopped or started distinguishing environmental compliance from non-compliance projects.


18

Tracking Environmental Costs

Moving from questions of capital budgeting in general to the question of environmentalcosting practices, our survey found 71% of respondents reporting that their company tracksenvironmental costs on a company-wide basis. This is a surprising finding. In work with manydifferent firms during the last five years, Tellus Institute has found few instances -- certainly lessthan the majority reported in this survey -- of accounting systems designed to tag or segregateenvironmental costs on a routine basis. The survey finding may be attributable to one or acombination of four explanations:

• the respondents self-selected in favor of those management accountants whose firms are moreapt to practice advanced environmental accounting methods;

• Tellus’ earlier work (White, Becker and Goldstein 1991a; White, Savage and Dierks 1995),

covering a diverse but small sample of firms, is not representative of company practices ingeneral;

• "tracking environmental costs" may be defined more loosely by respondents than intended by

the question, thereby leading to an increased number of positive responses; and • “company-wide” may have been loosely defined by respondents.

The nature of the question allowed respondents to either choose an option (“no”) that impliedtheir company did not track environmental costs at all or choose “company-wide” (“yes”). Inother words, “company-wide” was interpreted as “at all” or “at any level.”

Figure 9 depicts the most common organizational level at which environmental costs aretracked. Among those who track environmental costs company-wide, slightly under two-thirdsreported tracking at plant level and at the corporate level, and 44% at the divisional level. Thisprobably reflects the absence of divisions in many of the respondents' firms, as well as factorsrelated to the accounting structure. Figure 10 sheds further light on the tracking question. Herewe see the most common structure among those who track environmental costs is participation ofall three levels -- plant, division, and corporate -- followed closely by plant only and corporateonly. This response, as in the earlier "do you track" question, may also reflect varyinginterpretations of "environmental costs." Those firms who report the involvement of all threelevels probably have in place the most systematic and tiered procedure for compiling andreporting environmental costs originating at the plant level and moving up the corporatehierarchy. For those in almost equal numbers who report plant-only and corporate-only tracking,we suspect a less comprehensive and routinized tracking system. For example, plants maycompile relatively straight-forward costs like waste handling and disposal, whereas corporatetracking may focus on Superfund liability.


19

Figure 9. Level at which environmental costs tracked

(n=104, multiple answers accepted)

64%

44%

63%

0%

10%

20%

30%

40%

50%

60%

70%

Plant Divisional Corporate

Level

Per

cent

of r

espo

nden

ts


24%

11%

19%

1%

5%

12%

28%

0%

5%

10%

15%

20%

25%

30%

Plan

t onl

y

Div

isio

nal o

nly

Cor

pora

te o

nly

Plan

t & d

ivis

iona

l

Div

isio

nal &

cor

p

Plan

t & c

orp

Plan

t, di

v, &

cor

p

Level

Per

cent

age

of r

espo

nden

ts


20

How Wide is the Net?

Definitions of environmental costs are subject to enormous variation (GEMI 1994, Fagget al 1993). Figure 11 presents a three-part, "nested" scheme for distinguishing different types ofcosts (Shapiro, Savage, and White forthcoming). For most firms, current tracking practicesencompass only Box A (conventional costs) including items such as:

• off-site waste disposal,• purchase and maintenance of air emissions control systems,• utilities costs,• and perhaps costs associated with permitting of air or wastewater discharges.

Beyond this conventional cost domain is Box B, encompassing a wide range of less-tangible costs(and savings and revenue streams) such as:

• liability,• future regulatory compliance,• enhanced position in "green" product markets,• and the economic consequences of changes in corporate image linked to environmental

performance.

Probably more than any other less-tangible cost, especially in relationship to SEC requirementsand financial reporting in general, liability has been the subject of substantial discussion within andoutside the accounting profession (Canadian Institute of Chartered Accountants 1993; Surma andVondra 1992; Newell, Kreuze, and Newell 1990). Also included in Box B are changes in stockvalue linked to environmental performance, an elusive yet potentially significant less-tangible itemof special interest for publicly traded firms (Cohen 1995). Together, Boxes A and B comprise theinternal domain, the collection of costs for which firms are accountable (or otherwise experience)under current and foreseeable regulatory and market conditions.

THE COST INVENTORY


21

External Costs

Less Tangible, Hidden,Indirect Company Costs

A

Conventional Company Costs

B

C

Total Company Costs

Full Life-Cycle CostsInternal Cost Domain

External Cost Domain

Figure 11. Cost Boundaries

Box C comprises external costs, or "externalities" in the language of economics. Thesecosts entail those for which the firm is not accountable or are not of material economicconsequence to the firm under current and foreseeable regulatory and market conditions. Box Cmay include, for example, adverse health effects for air emissions that result even if suchemissions are within compliance levels; damages to buildings or crops resulting from SO2emissions; and irreversible damage to ecosystems or species owing to mining or forestry activities.A few firms have taken the first step toward developing accounting systems that track and, insome instances, report the physical and economic magnitudes of these external costs (Boone1995, Elkington 1991). Certainly the pronouncements of business leaders suggest that the futuremay see further corporate initiatives to track and report these costs as part of the generalmovement toward enlightened public accountability (Popoff and Buzzelli 1993; Andraca andMcCready 1994).

With continuously evolving U.S. environmental regulations and public expectations andwith emerging international environmental management systems standards, the boundariesdepicted in Figure 11 are anything but static. Costs in Box C today may well be in Box Btomorrow. In the same vein, the less tangible nature of Box B costs such as liability and


22

corporate image will change as more rigorous measurement techniques are developed to quantifysuch costs. For now, however, putting in place systems to more effectively track Box A and BoxB costs is the nearer-term, high-payoff challenge facing most firms.

Within this conceptual framework, what internal (Box A and Box B) costs are included inenvironmental project financial evaluation as reported by the management accountants in oursample? And to what extent are such costs quantified in the project justification process, asopposed to handled in qualitative fashion only?

The first of these questions, the inclusiveness of the cost inventory, is reported in Table 5.This table presents the percent of respondents who "normally" consider 28 different types of costs(or savings or revenues) in preparing financial justification for environmental projects. This costinventory includes items ranging from the conventional, tangible, and measurable -- e.g.,production efficiency/yield, energy, water, hazardous waste pre-treatment/treatment/disposal -- tothose which, in the eyes of most corporations today, would be regarded as less conventional, lesstangible, and less measurable (White, Becker, and Savage 1993).


23

Note that this list is neither exhaustive of all cost items that ought to be considered inproject justification, nor are the listed items pre-defined as "environmental." In fact, there is nosingle standardized list of "environmental costs" to which all firms adhere, nor is there likely to beone in the foreseeable future (Ditz, Ranganathan, and Banks 1995). Because environmental costsare simply those incurred in meeting the environmental objectives of the firm, and such objectivesvary across firms and even within firms at different points in time, developing a standardized list isinfeasible. Moreover, devoting substantial energy to defining what is and is not an

Table 5. Costs normally considered in financial analysis

Cost Item Percent who consider

On-site air/wastewater/hazardous waste testing/monitoring 79Energy costs 78On-site wastewater pre-treatment/treatment/disposal 77Licensing/permitting 76Water costs 74Production efficiency/yield 74On-site hazardous waste pre-treatment/treatment/disposal 71On-site hazardous waste handling (storage, labelling) 70On-site air emission controls 69Employee safety/health compensation claims 69Off-site hazardous waste transport 62Manifesting for off-site hazardous waste transport 59Staff training for environmental compliance 59Future regulatory compliance costs 59Environmental penalties/fines 57Insurance costs 55Corporate image effects 55Personal injury claims 54Reporting to government agencies 53Frequency of plant shutdown 51Off-site wastewater/haz. waste pre-treatment/treatment 50Property damage 50Environmental staff labor time 41Air pollutant emission credits (SOx, NOx) 40Marketable by-products 36Natural resource damage 31Legal staff labor time 28Sales of environmentally friendly/green products 25


24

"environmental" cost diverts attention from the fundamental challenge: enlarging the costinventory to ensure that all costs, environmental and non-environmental, are properly accountedfor in the capital budgeting process. Toward this end, Table 5 is empirically-based, containingcost items which are (a) associated with environmental projects and (b) frequently, in Tellus’experience, wholly or partially absent in appropriation requests for capital funds. For this reason,many conventional cost items such as equipment, direct labor, and raw material inputs do notappear on our list.

Scanning Table 5 reveals, aside from a few surprises, an ordering of cost items one mightexpect given the state-of-the-art of environmental accounting. The highest percent responses aregenerally costs which are front-line (often on-site) waste management costs that motivateenvironmental project proposals in the first place: on-site air/wastewater/hazardous wastetesting/monitoring, on-site wastewater pre-treatment/treatment/disposal, on-site hazardous wastepre-treatment/treatment/disposal, off-site hazardous waste transport, and waste manifesting. Byand large, they fall within Box A of Figure 11. All are considered by 60+ percent of therespondents.

Also included in the upper half (over 59% or greater) of responses are energy and watercosts. Though normally classified as standard utility costs, they nonetheless are subject to changeinsofar as environmental projects directly or indirectly alter the water and energy requirements ofa new production process. In the same vein, production efficiency/yield, which is normallyconsidered by about three-quarters of respondents, is usually not viewed as an environmental costper se. Nonetheless, product yield, for example, in the chemical and petroleum industry is often aconcurrent beneficiary of projects whose principle aim is emissions reductions through processmodifications or simply housekeeping measures.

One unexpected finding is the appearance of future regulatory compliance costs in theupper half of Table 5. Though marginally falling into the upper half (59% report that it isnormally considered), even this modest showing suggests that a significant number of firmsincreasingly are looking for ways to avoid future compliance costs in addition to controlling oreliminating current regulatory pressures. Such behavior -- reflecting a desire to get off the“regulatory treadmill" -- may portend a future of greater visibility for prevention-oriented projectsin the capital budgeting process.

At the lower half of the response list (57% or less) are costs that most firms would view asless tangible, though by no means less significant, contributors to the future stream of costs andsavings associated with environmental projects. In this category fall such costs as environmentalfines and penalties, corporate image, insurance costs, personal injury claims at the higher end ofthe response ranking; and marketable by-products, natural resources damage costs, legal stafftime, and sales of environmentally friendly/green products at the lower end of the responseranking. Not surprisingly, many of these costs are of a contingent, or probabilistic, nature. Thatis, whether and when they materialize, and what their costs to the firm will be, all are subject tosubstantial uncertainty. Nonetheless, acute events (e.g., fire, spill, or explosion) owing to the useor manufacture of hazardous materials do occur, and projects that reduce or eliminate theprobability of such accidents are rightfully credited with an avoided cost. A recent example of the


25

financial benefits of such risk reduction is demonstrated in an accelerated corporate-wide phase-out of PCBs by a large manufacturer (White, Savage, and Dierks 1995). In this instance, aproject which languished in the capital budgeting process was given new life and approved byupper management when the appropriations request incorporated explicit, quantitative, andmonetized estimates of avoided risks of a PCB spill, fire, and plant shut-down. Still, theresponses in Table 5 suggest that as a group, such contingent costs have yet to be routinelyincluded into the capital budgeting process for at least 40%, and as much as 69% (in the case ofnatural resource damages) of the firms represented by the respondents.

Other less tangible costs also are subject to omission by many firms. Corporate image,undoubtedly one of the most difficult to measure among all less-tangible costs, is normallyconsidered by 55% of respondents, a surprisingly high response (even if limited to a qualitativeconsideration) given the elusive nature of image effects. At 40%, air emission credits, a relativelynew development spurred by the Clean Air Act Amendments of 1990, may simply be outside therealm of possibilities for a majority of the respondents. Sales of environmentally friendly/greenproducts, at 25% the lowest response of all items, also may be applicable only to a small fractionof firms in the consumer product business. In contrast to primary or intermediate industries (e.g.,petroleum, most chemicals, metals), consumer products manufacturers are more sensitive toattaining a “green” product image that may be enhanced through certain environmentalinvestments.

Finally, insurance costs, reporting to government agencies, environmental staff labor time,and legal staff labor time are all cost items that traditionally fall within the centralizedadministrative functions of the firm. Their relatively high rate of omission from the capitalbudgeting process may be linked to the tendency to pool such costs in overhead categories (as wediscuss in the next section), thereby disconnecting such costs from the processes and sources thatgenerate them in the first place. Of course, for some environmental projects, managers maycorrectly view such costs as fixed - that is, invariant with respect to a proposed environmentalproject. Legal and environmental staff costs, for example, may not decline to any significantdegree as a result of a proposed environmental project; most of their environmentally-relatedfunctions --litigation, reporting, manifesting -- will continue in essentially the same fashion asbefore the project is implemented. However, firms should be cautious of making theseassumptions before such pooled costs are properly disaggregated. This will enable firms to clearlyunderstand what exactly these costs are, what portion is fixed and what portion is variable and,finally, which costs are controllable and which are not (Ditz, Ranganathan, and Banks 1995).

Are Environmental Costs Quantified?

Considering environmental costs in the capital budgeting process is an important, but onlya first, step in bringing rigor and comprehensiveness to the financial evaluation of environmentalprojects. Monetization of such costs -- estimating specific dollar values -- is the second andultimate measure of how far firms are in realizing the full benefits of a complete cost inventory,one which encompasses both tangible and less tangible internal costs as depicted in Box A and


26

Box B of Figure 11. To what extent, then, are "considered" costs also quantified? Among thosecosts normally considered in project financial evaluation, which are assigned a "specific dollarvalue" for costs or savings? Table 6 reports responses to this question. Note that the percentagesin Table 6 reflect responses provided by a subset of the total survey sample (i.e., those whoanswered "Yes" to the question of whether they consider a specific cost item at all in preparingenvironmental project financial evaluation).

Table 6. Cost items for which specific values are calculated among those who "consider" each cost

Cost Item Percent who calculate

Water costs 94Energy costs 92Production efficiency/yield 89Marketable by-products 89Frequency of plant shutdown 87On-site air/wastewater/hazardous waste testing/monitoring 84Licensing/permitting 84Insurance costs 84On-site hazardous waste pre-treatment/treatment/disposal 82On-site air emission controls 81On-site wastewater pre-treatment/treatment/disposal 81Environmental staff labor time 79Legal staff labor time 78Off-site hazardous waste transport 77Off-site wastewater/haz. waste pre-treatment/treatment 76On-site hazardous waste handling (storage, labelling) 75Environmental penalties/fines 75Sales of environmentally friendly/green products 73Air pollutant emission credits (SOx, NOx) 72Manifesting for off-site hazardous waste transport 71Personal injury claims 64Employee safety/health compensation claims 63Property damage 60Staff training for environmental compliance 59Future regulatory compliance costs 56Natural resource damage 55Reporting to government agencies 53Corporate image effects 26


27

Several findings in Table 6 are noteworthy. First, percentages are higher than in Table 5.This suggests that those who consider a particular cost item are inclined to take the next step andquantify such costs. For example, in the case of marketable by-products, only 36% consider thecost, but a full 89% of these respondents report quantifying this same item. Similarly, whereasonly 55% report considering insurance costs, 84% of those quantify these costs. This patternholds generally true across all cost items. The median value in Table 6 is 76.5%, well above the58% in Table 5. Indeed, for more than two-thirds of all cost items in Table 6, greater than 70%of respondents who report considering such costs also quantify them. Moreover, for one-third ofthese costs, over 80% report quantification. One not surprising exception is the first item in Table6, corporate image: 55% consider this cost while only 26% quantify it, less than half thepercentage of the second least-quantified item (reporting to government agencies). Image value isamong those less tangibles for which quantification techniques are essentially non-existent.Notwithstanding this exception, the overall message of Table 6 is clear -- more than conventionalwisdom may suggest, many firms are finding ways to quantify costs, even costs usually regardedas less tangible and difficult to monetize. Further understanding of how this occurs, thoughoutside the scope of this survey, is a valuable direction for future research.

Superfund Liability: Major or Minor Player?

Among all environmental costs on the minds of corporate managers, one deserves specialattention: Superfund liability -- the cost of remediating contaminated sites, which faces companieswho are identified under the law as "potentially responsible parties." With the strict, joint, andseveral liability standard of the Superfund law, firms that contributed wastes to any listed federalSuperfund site may be responsible for a small or large fraction of the costs of remediation as aresult of the negotiation process. How such costs are handled for purposes of SEC filings and forfinancial reporting in general has been the subject of voluminous discussion (CICA 1993; Crough,Cahan, and Leonard 1992; Edwards 1992; Newell, Kreuze, and Newell 1990; Price Waterhouse1994).

In this survey, our interest in Superfund liability is of a different nature. In contrast toissues of financial accounting and external reporting, we queried respondents as to if and howSuperfund liability affects various aspects of internal management decision-making in the area ofcapital budgeting. These questions are of interest for policy as well as benchmarking purposes.They are also of direct interest to EPA as the agency considers ongoing and future options forrestructuring Superfund programs to serve the multiple objectives of expediting the remediationof hazardous sites, equitably sharing the cost of such remediation, and creating the incentives toavoid future waste disposal practices that threaten human health and the environment.

The survey intentionally used the phrase “hazardous waste (‘Superfund’) liability” insteadof “Superfund” alone to help respondents quickly identify the kind of liability in which we wereinterested. However, for some in the business community, “Superfund” has evolved into ageneric term to encompass a wide range of costs associated with mismanaging waste, e.g.,administrative fines, penalties for corrective actions at waste sites imposed by states, and


28

violations of federal “RCRA” (waste transport and facility) regulations. Thus, while our surveysought to elicit corporate perspectives and practices specific to Superfund liability, the surveyrespondents may well have considered other waste-related liability as well in responding toquestions.

It is reasonable to speculate that after more than a decade the threat of Superfund costsmay be spurring environmental investments which eliminate the waste streams that eventually leadto Superfund clean-up costs for generating firms. Whether the threat is a strong or weakincentive (or no incentive at all) undoubtedly is firm-specific. Those firms involved as potentiallyresponsible parties (PRPs) in multiple sites already may have taken action to avoid future liabilityburden. This may occur in the form of:

1. regular certification and monitoring of waste disposal vendors,2. maintaining contractor-owned but dedicated disposal facilities,3. gradually moving all waste treatment and disposal to on-site systems,4. redesigning processes and materials that generate the hazardous waste stream in the first

place.

In some instances, incremental waste volumes shipped to a site that already is Superfund-listeddoes not necessarily lead to incremental liability exposure under the strict, joint, and severalliability standard of Superfund. Liability exposure will depend as much on which firms are PRPsand how "deep" their pockets are as it does on the volume and hazard of the wastes disposed byany individual firm. Recent initiatives to change Superfund’s strict, joint, and several liabilitystandard may alter the way liability burdens are spread among PRPs (Sussman 1994).

Keeping these variables in mind, we asked respondents if they consider "a project's effecton hazardous waste (Superfund) liability in preparing an appropriations request for environmentalprojects." Among all respondents, only 32%, or slightly less than one-third, indicated they doconsider Superfund. A "No" response to this question does not preclude the possibility thatSuperfund is acting as a driver to improved corporate environmental management practicesoverall, e.g., improved materials accounting, record-keeping, monitoring, and manifesting.Superfund liability may also affect the degree of scrutiny firms apply in selecting waste transportand disposal vendors, since mismanagement by vendors can result in penalties for the wastegenerator. Nonetheless, the low "Yes" response rate does suggest that Superfund liability, incomparison to other items in the firms' cost inventory, has yet to enter the capital budgetingdecisions of most firms surveyed.

Because liability is one of a family of contingent costs which, as earlier discussed, issubject to the vagaries of many variables (e.g., future waste volumes and composition, the qualityof on-site waste treatment, the distance to and site of disposal facilities, and even the number andeconomic resources of PRPs), firms are understandably reluctant to place a dollar value on futureSuperfund liabilities. Reinforcing this view is the belief that quantification itself may subject thefirm to higher penalties in the event that it becomes a PRP. Some managers fear that


29

quantification of liabilities is, in effect, an admission of known (and, by implication, preventable)risks which in future may be held against the firm in the course of litigation.

How, then, is liability handled among firms that do consider it in the project financialevaluation process? Figure 12 shows a mix of responses, split between qualitatively only (33%),specific dollar value (23%), and a combination of qualitative and quantitative (44%). Focusing


30

on the second category, and remembering that Figure 12 reflects the practices of only thoserespondents who consider liability (1/3 of all respondents), then only about 7% of all surveyrespondents regularly quantify liability during project financial evaluation. Even if we assume halfof the "mixed" responses (.5 x 44%) regularly quantify, the figure rises to 14% of all surveyrespondents. Thus, it appears that liability quantification remains a practice of few mid- andlarge-size firms in the U.S. manufacturing sector.

Figure 12. How Superfund is handledn = 50

Qualitatively only33%

Specific $ value23%

Both qualitative and quantitative

44%

Whether quantified or not, the firms that consider liability in any form report a variety ofapproaches and staff responsibilities. The most common situation (42%) among the three specificoptions given in the survey is consideration by financial or legal staff when reviewingappropriations requests prepared by environmental or other staff. This suggests that if liability isconsidered in any form, it appears after financial evaluation is complete and a project is brought toupper management for final review and approval. At this juncture, liability benefits of a projectmay be handled in a side bar, discussed as a less tangible or contextual variable in a column of theappropriations request typically labeled "other considerations" or "non-quantifiable issues." Infewer instances, liability is left to the individual preparer's judgment (22%) or, alternatively, thissame individual follows guidelines from financial or legal staff (26%). That only a quarter of allrespondents report the latter is consistent with earlier findings that most firms -- owing to eitherlegal concerns or skepticism about quantifiability -- remain hesitant to systematize theirconsideration of liability in project financial evaluation. For the few who do, the most common(74%) approach is a method developed internally. For the remainder, the EPA PollutionPrevention Benefits Manual (U.S. EPA 1989) is a distant second.


31

Many variables form part of the liability equation, but a few dominate the methods used bythose respondents who consider liability in any form. Figure 13 shows that waste volume, wastetoxicity, and waste form (solid, liquid, gaseous) are the three most frequent variables, followed bytreatment technology, transport mode, and compliance status of receiving facility. These variablescomprise the core considerations in the engineering approach to liability estimation, in which riskis assumed to be driven principally by the hazard level of the material, transport mode, andreceiving facility (MacLean 1987, General Electric Corporation 1987, Aldrich 1994). Analternative approach adopts an actuarial perspective in which risks are based on the frequency ofpast incidents and legal verdicts in cases roughly analogous to the conditions under consideration,i.e., similar chemical composition and volumes, similar waste treatment methods, and similar typeand size of manufacturing firm (White, Savage, and Dierks 1995). Both approaches have theirstrengths and limitations. From the responses in this survey, it appears that the engineering

approach remains dominant.

From the perspective of all respondents, including those that do not currently considerliability in the project evaluation process, what stands in the way of quantifying liability in thefuture? By a substantial margin, the most frequently cited hurdle (58%) is difficulty in estimatingif liability costs will occur. Following this is the difficulty in estimating the magnitude of costs(45%) and when liability will occur (29%). Contrary to conventional wisdom, remarkably few

Figure 13. Factors accounted for by Superfund liability assessment method (n=50, multiple answers accepted)

36% 38% 40%44% 46%

52%58% 60%

76%80% 82%

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identified "If I quantify, I may be subject to toxic torts" (5%) and "If I quantify, I have to discloseto the SEC" (3%). The conventional wisdom holds that legal repercussions are a significantbarrier to disclosure. Our findings suggest, however, that this is not the case: methodologicalbarriers are a far greater impediment to calculating liability.

The "when" of liability estimation is a particularly critical variable of financial evaluationowing to the powerful effects of discounting and the time value of money. A liability costincurred in year 5 of a project's life has a dramatically greater impact on project profitability than acost incurred in year 10. Of course, all three barriers -- estimation of if, at what magnitude, andwhen liability costs will materialize -- lie at the heart of any risk analysis. The perception thatthese are the key barriers may be related to the unfamiliarity of the management accountingcommunity with the techniques of risk analysis as well as the reluctance to deal with expectedvalues (rather than the customary solid and certain costs) in managing the firms' economicresources. This suggests an opportunity and need to bring risk analysis techniques to theattention of the accounting community to strengthen its capacity to handle key less tangible costs.

What does the future hold for incorporating Superfund liability in the capital budgetingprocess? A total of 61% of all survey respondents indicated that Superfund liability was eithervery important (27%) or somewhat important (34%) in determining priorities for environmentalprojects. This is almost double the number who currently consider liability in developing projectappropriation requests. The results suggest that the general appreciation of liability avoidance asan environmental project benefit far exceed concrete steps to formally bring this cost into theproject evaluation process, a situation undoubtedly linked to the methodological issues mentionedearlier. When asked if they have plans in the next two years to consider liability in the budgetingprocess, only 23% of those who currently do not consider this cost item plan to change practicesduring this time frame. This suggests that relatively few respondents are poised to dramaticallydepart from current practices.


33

hen firms incur environmental costs that they do not link to processes and products,managers are deprived of a clear picture of where and how costs are generated. Even in

modest-sized manufacturing firms with two or three production lines, the costs of licensing,monitoring, waste storage, emissions controls, environmental staff time, off-site disposal,insurance, future regulatory compliance, and even liability are not driven equally by eachproduction line. Some process lines may be more hazardous materials-intensive, generate moreemissions per unit output, require more frequent and intensive inspection and monitoring, andgenerate greater quantities of waste requiring off-site disposal. Similarly, particular processes, orproducts, may cause a disproportionate share of costs associated with training and reporting togovernment agencies, or give rise to risks which may result in higher insurance costs or risks offuture personal or property damages. In short, when it comes to environmental costs, not allprocesses and products are created equal.

Numerous observers have recognized the complexity, consequences, and necessity ofrationalizing accounting systems to ensure proper allocation to the sources within the firm that areresponsible for such costs (Johnson and Kaplan 1991, Cooper et al. 1992, Todd 1994, Ness andCucuzza 1995). Understanding cost drivers and allocating costs accordingly is the conceptualcornerstone of activity-based costing (ABC). ABC has evolved rapidly since emerging as a newmanagement tool in the 1980's. It is an approach to cost management that moves managementfocus beyond the traditional emphasis of short-term planning, control and decision-making, andproduct costing to a more integrated, strategic, competition-sensitive way of looking at internalcosts structures. It is especially germane to environmental costs because of the diffuse, long-term,and less tangible nature of so many environmental costs, all attributes that make allocationparticularly challenging from an accounting perspective.

In its first generation, ABC helped redefine cost drivers to move beyond factors such assimple volume measures to include "transaction" cost drivers such as setups, work orders,product lines, and others with a non-linear relationship to output levels (Mecimore and Bell1995). At the same time, first-generation ABC articulated the critical difference between value-added and nonvalue-added components, thereby directing management attention to eliminatingthose steps in the production process that added nothing to product value yet consumed the firm'sresources.

In rapid succession, second-generation ABC defined process-related costs - those linkedto but distinct from the narrow confines of production (e.g., distribution, selling, and varioussubcomponents of administrative expenses, such as procurement of people, supplies, andequipment). Ignoring these costs is incompatible with the modern concept of continuousimprovement since such improvement requires an integrated and encompassing perspective ofstages in the product cycle and the cost implications of each stage.

COST ALLOCATION

WW


34

Most recent, third-generation ABC enlarges the scope of costs to focus on the businessunit (versus only the cost center), the firm's activities (versus only products and processes),internal and external costs (versus only manufacturing, administrative, and selling), and "valuechain costing" (versus only product costing and process-costing). Through this enlarged vision ofwhere and how costs are created, it enables managers to think and act strategically, and to attendto activities upstream and downstream of the immediate production process.

While improved allocation cannot help but rationalize management decisions, it is neitherwithout cost itself nor without consequences for product line and facility managers. The value ofdisaggregating cost information must always be weighted against the benefits of doing so. Settingup and maintaining the accounting infrastructure to collect, analyze, and report on a continuingbasis highly disaggregated information requires staff hours to both operate the system and digestits outputs. Though modern information technology allows for such intricate cost accountingsystems, and even the co-existence of two systems (for internal and external reporting), start-upcosts can be high even if amortized over many years of decision-making.

In addition to resource requirements, another organizational barrier to ABC isnoteworthy. Improved allocation may be good news to some managers struggling to justifyfacility expansion when pooled savings or revenue streams (environmental or otherwise) areremoved from overhead and applied to specific processes and products. However, the conversealso is true. New allocation methods may be unwelcome news to product or facility managerswhose operations appeared to be profitable under the old overhead allocation methods but whoare suddenly tagged with formerly pooled costs. Temporary protection against penalizing suchmanagers is essential to building staff investment in the accounting methods while avoiding thedispiriting effects of winners abruptly becoming losers.

The allocation challenge is further complicated by the recognition that even processes andproducts may not provide an adequate basis for allocating costs. Instead, it is "activities" of thefirm -- introducing a new product line, set-up time, distribution, marketing -- that are the true costdrivers (Cooper 1989; Cooper and Kaplan 1991; Cooper et al. 1992). In any case, the challengeis certainly not confined to environmental costs; misallocation of any type of cost distorts theinformation which management depends on to conduct a host of essential and routine businessfunctions. These functions include: pricing products, determining product mix, evaluatingopportunities for cost control, rewarding plant managers for efficiency gains, and justifying plansfor capacity expansion.

Environmental costs are just one target for correcting typical allocation practices.However, because they traditionally are lumped into overhead/administrative accounts, andbecause of their often less tangible and difficult-to-quantify nature, environmental costs areparticularly susceptible to disconnection from the products, processes, or activities responsible fortheir creation. Yet, learning from recent studies, misallocating costs that may represent as muchas 20% of the controllable operating costs of a facility cannot help but have adverse consequencesfor management of many business decisions (Ditz, Ranganathan, and Banks 1995).


35

To obtain a glimpse of current practices, we asked respondents to describe their currentcost allocation across a range of 17 environmental costs (Table 7). These were selected from theearlier cost inventory list based on experience in assessing the capital budgeting procedures in awide variety of firms (Tellus Institute 1993). For each cost, one of four responses was possible,ranging from allocating "always to overhead" to "always to product/process,” with the latterrepresenting the practice most consistent with the objective of linking costs to sources.

A number of findings in Table 7 are noteworthy. First, for every cost item, "always tooverhead" is the most frequent response. Virtually all costs fall in the 55-75% response range,with the notable exceptions of energy and water costs. That these should be allocated with

Table 7. Initial assignment of costs

1 2 3 4

Always to overhead

Usually to overhead

Usually to product/ process

Always to product/ process

On-site air/wastewater/hazardous waste testing and monitoring

58 23 12 7

On-site air emission controls 56 24 15 5

On-site wastewater pre-treatment/treatment/disposal

57 22 16 4

On-site haz. waste pre-treatment/treatment/disposal

58 23 15 4

On-site hazardous waste handling (e.g. storage, labelling)

56 22 18 5

Manifesting for off-site hazardous waste transport

58 29 9 4

Off-site hazardous waste transport 58 28 10 5

Off-site wastewater/haz. waste pre-treatment/treatment

53 28 14 6

Energy costs 44 22 23 12

Water costs 51 23 18 9

Licensing/permitting 60 29 8 4

Reporting to government agencies 65 28 6 1

Environmental penalties/fines 67 24 8 2

Staff training for environmental compliance 64 27 7 1

Environmental staff labor time 68 26 4 2

Legal staff labor time 74 23 2 1


36

slightly greater frequency to products or processes is not surprising: relative to other cost items,they are more measurable and physically traceable to processes that are energy and waterconsumers. But at 44% for energy and 51% for water, the difference is small and certainly fallswell short of consistent allocation to processes and products.

Second, those costs with the highest column 1 percentages -- from licensing/permitting toinsurance costs -- are those most typically associated with central staff functions or plant-,division-, or corporate-wide overhead costs. Legal, environmental, and training staff, forexample, typically charge their time to general accounts which bear no relationship to theprocesses, products, or activities which require their services.

Third, the pattern of highest to lowest percentages across rows holds for all costs in Table7, with the sole exception of energy showing a slightly higher percentage response in column 3versus column 2. Thus, while there may be as much as 20% difference in column 1 figures, thepattern of diminishing frequency from overhead to product/process allocation holds steadily for allentries, regardless of how tangible they happen to be. This finding comports with earlieranecdotal evidence gathered in case studies of corporate environmental cost management, whichsuggests that environmental costs, at least in the initial stage of accounting, are pooled intooverhead accounts (Ditz, Ranganathan, and Banks 1995).

For some firms, initial allocation to overhead is not the last step in the accounting process.When asked "if some or all costs are initially assigned to an overhead account, do you laterreallocate to a product or process," 58% of the sample answered "Yes." Thus, for roughly 70-80% of respondents (depending on the specific cost item) who "always" or "usually" first allocateto overhead, well over half then proceed to move such costs to products or processes using sometype of allocation formula. Taking 75% as the average of those who always or initially allocate,and multiplying that figure times the 58% who subsequently shift costs to products or processes,we find that about 44% of all respondents follow this two-step procedure.

Allocation requires some driver, or basis, for partitioning costs across processes andproducts whether it occurs initially (as in the case of 15-20% of respondents) or in a second step(as it does for 44%). Figure 14 shows the range of such cost drivers when firms were given fivechoices and asked to identify the two most commonly used. Labor hours (55%) and productionvolume (53%) are by far the most common, followed by materials use (27%) and square footageof facility space (24%). An assortment of "other" drivers were mentioned, including:machine/equipment hours, engineering estimates, the speed with which products flow through thefacility, head count, number of set-ups, and tons made. One respondent noted that "eachoverhead account has its own unique driver that is used to allocate costs,” and another answeredthat the driver "depends upon the origin of the cost and the relationship to a product line activity,and could be any or a combination of the above."


37

Finally, Figure 15 provides some insight into the sources of cost information used to makeallocation choices. With each respondent allowed to name up to three sources,financial/accounting systems data is the most frequent source (mentioned by 51% of respondents),followed by purchasing, production/operation logs, engineering estimates, and materials tracking,all with scores of at least 20%. This diversity of sources reaffirms what is increasingly evident inenvironmental accounting case studies: essential environmental cost information is spreadthrough multiple staff functions, and modifying accounting systems to better track and allocatesuch costs necessitates a cross-functional approach to ensure completeness and compatibility ofinformation. It is fair to say that as firms move toward greater coverage in their environmentalcost inventory and better assignment of costs to processes and products, more and more stafffunctions are inevitably drawn into the environmental accounting process.

Figure 14. Basis for allocating costs to product/processes from overhead

(n=88, two answers accepted)

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Figure 15. Sources of Cost Information When Assigning Costs to Products/Processes

(n=88, three answers accepted)

1%3% 5%

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mproving cost inventory and cost allocation methods are major steps toward improving theevaluation of environmental projects in the capital budgeting process. However, there remain

two other variables that play a decisive role in determining whether projects survive the intensecompetition for scarce capital resources: the choice of project financial indicators and the relatedissue of time horizons.

In addition to their less tangible and contingent nature, many environmental costs andsavings materialize only in the mid- and long-term. In contrast to costs of activities such as on-site air and hazardous waste testing, monitoring, handling, and manifesting, other costs (orsavings/revenues) linked to corporate image, liability, and green product sales are by nature thosewith longer-term time horizons. In the case of future compliance costs, its very definition impliesa cost that will materialize only some years into the future. Thus, if any of these costs form partof the cost/benefit calculation of a proposed environmental project, an analytical method that isinsensitive to mid- and long-term cost and revenue streams will be incapable of capturing thelong-term profitability of a proposed project. Pollution prevention projects are especiallyvulnerable to this shortcoming because many rely on product redesign, process modification, andmaterials substitutions that may be capital intensive but yield attractive returns beginning 3-5 yearsafter the initial capital outlay.

To take stock of current practices, we asked respondents a series of questions regardingtheir current selection and application of profitability indicators for evaluating environmentalprojects. Seventy-four percent of respondents indicated they perform "a less detailed/informalscreening" of environmental projects prior to a detailed financial analysis. This common practiceallows firms a quick glimpse of a project's economics before committing the resources requiredfor a full financial evaluation. If a project appears profitable at this juncture, many firms do notconduct a more in-depth evaluation. If a project does not appear profitable after the first quickscreening, then expanding the cost inventory and more rigorously allocating costs to depict thetrue costs of a current practice may make the difference in illustrating the benefits of an alternativepractice. This tier-type approach -- beginning with conventional, tangible costs and then moving,as necessary, to less tangibles, was first advocated in EPA's Pollution Prevention Benefits Manual(U.S. EPA 1989). Of course, an enlarged cost inventory may reveal hidden costs as well assavings, thereby making a project less, rather than more, profitable.

For those firms performing any initial screenings, Figure 16 shows that Return onInvestment (ROI, 36%) and Payback (34%) are the most commonly used financial indicators.These are followed by Internal Rate of Return (IRR) and Net Present Value (NPV), both at 23%.Interestingly, 16% of respondents report use of qualitative methods only. ROI, IRR, and NPVfall into the category of discounted cash flow methods, which take into account the time value ofmoney. They usually, though not necessarily, cover a time horizon longer than the 1-2 yearperiod typical of Payback analysis, which does not incorporate discounting methods. Many firmsmay look at ROI, IRR, or NPV over a relatively short horizon, say five years or less. In thesecases, excluding the long term costs and benefits of a P2 project (e.g., omission of the expected

FINANCIAL INDICATORS: THE BOTTOM LINE

II


40

value for the avoided liability in Year 8, or anticipated compliance costs in Year 6) may bias theprofitability analysis to the disadvantage of the proposed P2 project. In any case, over half ofthose firms who do screen use some form of discounted cash flow method.

Figure 16. Financial indicators used for screening projects (n=102, multiple answers accepted)

3% 3%

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ts


41

Turning to the full project justification, a somewhat different pattern emerges (Figure 17).Once again ROI is the leading quantitative indicator, followed by IRR at 18%. However, for 27%of respondents, the single most frequent response reported in Figure 17 is that their "evaluation isqualitative only." This strikingly high figure is nearly twice as high as the comparable figure forthe project screening phase.

Figure 17. Financial indicators used for full project justification

None, qual. only28%

Other4%

ROTA2%

IRR18%

Payback12%

ROI24%

NPV10%

Profitability index2%

How might one explain this finding? While we cannot be certain from the survey data, aclue may reside in a follow-up question as well as in side comments from a handful of respondentswho noted (unsolicited) that environmental projects are "legally required,” "mandated" and"required." When asked if the preferred financial indicator is used for "regulatory complianceprojects as well as non-compliance, or discretionary, projects," 44% responded "No." Thissuggests that some, perhaps most, who report qualitative evaluation during full project evaluationare those who lump all environmental projects into the "must-do" category. This, more often thannot, unfortunately leads to the concurrent and often erroneous conclusion that systematic financialanalysis of environmental projects is not necessary and may be a waste of the firm's resources.

The choice of hurdle rates -- the threshold economic return to gain project approval --offers still another perspective on how environmental projects are handled vis a vis other projectswhich enter the capital budgeting process. Among all respondents, 56% indicate no "standardhurdle rate, or threshold" is required before approving an environmental project. This suggeststhat a slight majority of firms exercise discretion in reviewing the profitability of projects, perhapstaking into account the less tangible benefits that, in their view, are not amenable toquantification.


42

Among those respondents who use Payback at any stage of project justification, 1-2 yearsis by far the most common (50%) hurdle rate required for project approval (Figure 18). Only 8%report payback periods of greater than 4 years. Limiting the analysis to this time frame introducesa substantial probability of omitting outyear benefits common to many P2 projects. For IRR users(Figure 19), hurdle rates are defined in percentage terms. Here the most frequent range is 10-19% (48% of respondents), followed by 20-30% (25%) and greater than 30% (18%).

Figure 18. Payback period used, payback users only (n=72)

10%

50%

32%

8%

0%

10%

20%

30%

40%

50%

60%

Lessthan 1year

1-2years

3-4years

Greaterthan 4years

Payback period

Per

cent

of r

espo

nden

ts


43

Figure 19. IRR required for approval, IRR users only (n=61)

10%

48%

25%

18%

0%

10%

20%

30%

40%

50%

60%

Lessthan10%

10-19%

20-30%

Greaterthan30%

IRR required

Per

cent

age

of r

espo

nden

ts

Time horizon also may play a decisive role in the environmental project approval process.For those who use NPV, or normalized NPV, 47% use a 6-10 year time horizon and another 6%use 10 years or greater (Figure 20). For IRR users, the comparable figures are 49% and 3%(Figure 21). Thus, consistent with the underlying differences between Payback versus NPV andIRR, those who use discounted cash flow methods are markedly more inclined to take a long-termview of the economics of their environmental investments.


44

Figure 20. Time horizon for NPV, NPV users only (n=51)

47% 47%

6%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

1-5years

6-10years

Greaterthan 10

yrs

Time horizon

Per

cent

of r

espo

nden

ts

Figure 21. IRR time horizon used, IRR users only (n=65)

48%49%

3%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

1-5years

6-10years

Greaterthan 10

yrs

Time horizon

Per

cent

of r

espo

nden

ts


45

Finally, we queried respondents as to whether hurdle rates for environmental projectsdiffer from those applied to non-environmental projects (Figure 22). Again, the earlier biastoward special treatment of environmental projects becomes evident. While a majority (57%)report equal hurdle rates, a notable 36% report that hurdle rates are lower for environmentalinvestments. These respondents undoubtedly include a range of perspectives, from those who useno threshold whatsoever (the "must-do" viewpoint) to those who exercise discretion owing to theknowing exclusion of, but appreciation for, the less tangible costs associated with environmentalprojects.

How persistent thispractice has been over time mustremain conjecture since we donot enjoy the benefit of an earliersurvey against which tobenchmark our findings. Thereported different hurdle ratesstand in contrast to the finding,discussed earlier, that the vastmajority of firms (86%) do notmaintain separate budget poolsearmarked for environmentalprojects. Some recent evidencesuggests that environmentalissues increasingly will blend intothe more general practices andtrends that continue to redefinecorporate organizational andcompetitive strategy (e.g., re-engineering, total quality management, product stewardship). Themeshing of overall corporate strategy with environmental performance certainly bodes well for P2projects. Projects that focus on upstream processes and materials (as P2 normally does) oftensimultaneously increase efficiency and enhance systems performance, while reducing pollution.These joint results render moot the traditional distinctions between environmental and non-environmental projects.

Equal treatment is rational management provided that cost inventory and cost allocationmethods are systematic, rigorous, and applied equally across all types of projects, and financialanalysis provides a clear picture of true profitability. The evidence collected in this surveysuggests that many firms still are inclined to quickly dismiss environmental projects as "must-do"mandates, subjecting them to perfunctory or no systematic profitability assessment. In so doing,opportunities often are lost for discerning between alternative methods for achievingenvironmental compliance. While barriers to P2 persist, regulations increasingly allow flexibilityin meeting standards. Simple distinctions between compliance and non-compliance projectsincreasingly are obsolete; multiple options for achieving compliance include P2 approaches,which, if thoughtfully conceived, promise to make positive contributions to broader

Figure 22. Approval thresholds for environmental projects compared to non-environmental projects

Higher for environmental

projects7%

Same for environmental

projects57%

Lower for environmental

projects36%


46

corporate strategic objectives. It is these dual and commingled benefits that may elude thosefirms who are too quick to pigeonhole all environmental projects as capital drains with negativerates of return.

Whether a single budget pool and uniform hurdle rates for all projects are becoming thenorm in U.S. manufacturing firms (not just relatively larger ones which dominate our sample) canonly be answered in future studies.


47

mong the many internal business functions served by environmental cost information, capitalbudgeting for environmental projects is one of the principal beneficiaries. Accounting

systems to identify, compile, analyze, and report environmental cost information in a timely andrigorous fashion is a prerequisite to understanding the sources and magnitude of environmentalcosts in the firm. Only if these are understood can managers maintain a clear picture of the truecosts of current production processes and products. This, in turn, allows managers to directattention to minimizing compliance costs, reducing operating costs, and fully meshing theenvironmental and financial performance goals of the organization.

With few exceptions, this survey of management accountants of U.S. manufacturersconfirms anecdotal evidence based on earlier case studies of capital budgeting for environmentalinvestments in large and medium-size firms. Some key findings consistent with earlier studiesinclude:

• The budgeting function normally is a tiered process, with participation of plant, division,and corporate levels the single most common arrangement.

• Discretionary spending of $100,000 or less on capital projects is allowed in virtually all

firms. • Environmental cost information is gathered by many staff functions located throughout the

firm; production/operations, environmental, and finance/purchasing are the most frequentcontributors.

• Tangible, quantifiable environmental costs are normally considered by well over half of all

firms; less tangible, more difficult to quantify environmental costs are less often normallyconsidered in the capital budgeting process.

• Costs that are considered at all are generally quantified; the more tangible and quantifiable

they are, the more often they are monetized in project evaluation. • Only a third of respondents consider the effect of a proposed environmental project on the

firm's Superfund liability exposure, and only 7-14% regularly quantify such costs. • Initial allocation to overhead accounts is the most common practice for a majority of firms

for virtually all types of environmental costs; routine initial allocation to products orprocesses is reported by under 10% of respondents for virtually all environmental costs.

However, some unexpected findings also emerged from the survey:

CONCLUSIONS

A


48

• Over eight out of ten respondents -- 86% -- report a single funding pool for all projects,environmental or otherwise.

• A majority of firms (71%) track environmental costs in some form at the corporate level. • Among the few firms that quantify liability, three quarters use methods developed

internally as opposed to those available through EPA or other public sources.

Concerning the key issues of environmental cost inventory and cost allocation methods,the survey suggests that much work remains before business practices can provide managers witha comprehensive and transparent look at "true" costs of processes and products. While mostfirms quantify the more obvious and measurable environmental costs, substantially fewer havegrappled with those that are less tangible, uncertain, and difficult to quantify. Estimates ofenvironmental costs in the range of 3-20% of facility operational or product line costs as reportedin other studies may, after a closer look, be substantially understated when the less tangible costsare added.

Dealing systematically with these types of costs is not new to corporations. In the normalcourse of business, managers regularly look into the future to forecast everything from the priceof oil to consumer demand for a new line of computers. Applying these approaches, includingthose drawn from risk analysis, to estimate less tangible costs would represent a major steptoward characterizing current and future environmental costs.

Cost allocation, too, remains a major challenge. Most firms continue to place mostenvironmental costs initially into overhead accounts. Though some subsequently allocate thesecosts to products or processes, the basis upon which these allocations are made are often ill-conceived. When proper allocation does not occur, managers receive distorted signals regardingthe true costs and benefits of retaining or changing processes and products. Moreover, likeincomplete cost inventories, misallocation of environmental costs stands in the way of effectiveperformance monitoring, product pricing, incentive and reward systems, and other activitiesessential to maintaining a competitive enterprise.

Upgrading the capital budgeting system through improved environmental accountingsystems is best viewed in the broader context of strategic planning. With multiple forces workingto fuse environmental and financial objectives of the firm, it is critical to exercise an even hand inevaluating the returns to all capital investments, environmental or otherwise. When cost inventoryand cost allocation practices fail to provide a level playing field for all investments, managers areleft without the information they need to make optimal use of limited resources. In particular,those environmental projects with strong pollution prevention content, as well as those with sidebenefits unrelated to environmental improvement per se -- e.g. process optimization and yield,market penetration, corporate image -- are particularly vulnerable to the adverse effects ofincomplete cost information.

While many social benefits may result from improved internal environmental accounting,the case for such improvements may be made purely on the basis of the firm's self-interest. This is


49

the central message that public policymakers, professional associations, trade associations andstakeholders should deliver to firms seeking to understand and apply environmental accountingtechniques to their capital budgeting processes.

R-1

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APPENDIX A

ADVANCE AND FOLLOW-UP LETTERS TO SURVEY RESPONDENTS

APPENDIX B

SURVEY QUESTIONNAIRE

Figure 1. Respondent's product line (by SIC code)

28, 29: Chemicals, Petroleum/Coal

12%

22, 23: Textiles, Apparel6%

27: Printing3%

24, 25, 26: Lumber, Furniture, Paper6%

20, 21: Food, Tobacco8%

30: Rubber/Plastics1%

33, 34: Metals12%

32: Stone/Clay/Glass4%

35-39: Industrial/Electric/Transportation Equipment, Instruments, Miscellaneous

Manufacture48%

Figure 2. Respondent's position at firm

Divisional 31%

Corporate32%Plant

37%

Figure 3. Number of employees worldwide

8%

24%26%

42%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

< 200 200 - 999 1000 - 5000 >5000No. of employees

Per

cent

of c

ompa

nies

Figure4.dc

Page 4

Figure 4. Most recent annual sales

3

26

22

49

0

10

20

30

40

50

< $10million

$10 -100

million

$101 -$500

million

> $500million

Annual sales

Per

cent

res

pond

ents

figure5

Page 5

Figure 5. Annual corporate budget

< $0.5 million5%

$1 - $10 million38%

> $10 million51%

$0.5 - $1 million6%

Figure6.dc

Page 6

Figure 6. Level at which capital budgeting occurs

Other3%

Corp, div, & plant30%

Corporate only17%

Division only16%

Plant only16%

Corporate & plant6%

Division & plant5%

Corporate & division 4%

Corp, div, plant, other

3%

9

Figure 7. Limit on discretionary capital spending

28

1412

18

12

17

0

5

10

15

20

25

30

35

no limit up to$5000

up to$10,000

up to$50,000

up to$100,000

other

Spending Limit

Per

cent

of r

espo

nden

ts

Figure 8. Who makes the initial decision to place an environmental project in a particular category?

Divisional finance/accounting

6%

Plant finance/accounting

12%

Plant environmental29%

We do not use categories

15%

Other 12%

Divisional environmental

8%

Corporate finance/accounting

12%

Corporate environmental

6%



64%

44%

63%

0%

10%

20%

30%

40%

50%

60%

70%

Plant Divisional Corporate

Level

Per

cent

of r

espo

nden

ts


24%

11%

19%

1%

5%

12%

28%

0%

5%

10%

15%

20%

25%

30%

Plan

t onl

y

Div

isio

nal o

nly

Cor

pora

te o

nly

Plan

t & d

ivis

iona

l

Div

isio

nal &

cor

p

Plan

t & c

orp

Plan

t, di

v, &

cor

p

Level

Per

cent

age

of r

espo

nden

ts

q17a-cdata

Q17a-c

Plant only 24%Divisional only 11%Corporate only 19%Plant & divisional 1%Divisional & corp 5%Plant & corp 12%Plant, div, & corp 28%

Page 11

Datafig4,7

< $10 million 3$10 - 100 million 26$101 - $500 million 22> $500 million 49

Other 3Corp, div, plnt, oth 3Corp, div, & plant 30Corporate & plant 6Division & plant 5Corporate & division 4Corporate only 17Division only 16Plant only 16

Page 12

Q12,13data

Q12 data

One for all capital projects 86Separate for all environmental projects 11Separate for compliance projects 3

Q13 data

No set cap 40Cap on total amount 5Cap on % of total annual corporate budget 1Varies from year to year 54

Page 13

Figure 11. Budget pools

Separate for all environmntal

projects11%

One for all capital projects

86%

Separate for compliance

projects3%

Q7,17data

Q7 Level capital budgeting occurs in firm(n=149)

Plant 61%Division 58%Corporate 61%Other 5%Q17.Level at which environmental costs are tracked(n=104)Plant 64%Divisional 44%Corporate 63%

Page 15

Figure 12. Typical annual spending

No set cap40%

Varies from year to year54%

Cap on total amount

5%Cap on % of total annual corporate

budget1%

Figure 6. Level at which capital budgeting occurs(multiple answers accepted)

61%58%

61%

5%

0%

10%

20%

30%

40%

50%

60%

70%

Plant Division Corporate Other

Level

Per

cent

of r

espo

nden

ts

Q1data

Q1

20, 21: Food, Tobacco 822, 23: Textiles, Apparel 624, 25, 26: Lumber, Furniture, Paper 627: Printing 328, 29: Chemicals, Petroleum/Coal 1230: Rubber/Plastics 132: Stone/Clay/Glass 433, 34: Metals 1235-39: Industrial/Electric/Transportation Equipment, Instruments, Miscellaneous Manufacture47

Page 18

Q1data

8663

1214

1247

Page 19

Sheet5

no limit 28up to $5000 14up to $10,000 12up to $50,000 18up to $100,000 12other 17

< $0.5 million 5$0.5 - $1 million 6$1 - $10 million 38> $10 million 51

Page 20

Q4data

< 200 8%200 - 999 24%1000 - 5000 26%>5000 42%

Page 21

Q2,11data

Q2 dataCorporate 32Divisional 31Plant 37

Q11 dataCorporate finance/accounting 12Divisional finance/accounting 6Plant finance/accounting 12Corporate environmental 6Divisional environmental 8Plant environmental 29We do not use categories 15Other 12

Page 22

Figure12.dc

Page 1

Figure 12. How Superfund is handledn = 50

Qualitatively only33%

Specific $ value23%

Both qualitative and quantitative

44%

Figure 13. Factors accounted for by Superfund liability assessment method


36% 38% 40%44% 46%

52%58% 60%

76%80% 82%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

Lia

bilit

y hi

stor

yw

aste

mgm

t

Tra

nspo

rt d

ista

nce

Tim

ing

pote

ntia

llia

bilit

y

Lia

bilit

y hi

stor

y-fi

rm

Perf

. his

tory

-re

ceiv

er

Com

plia

nce

stat

us-

-rec

eive

r

Tra

nspo

rt m

ode

Tre

atm

ent

tech

nolo

gy

Was

te fo

rm

Was

te to

xici

ty

Was

te v

olum

e

Method

Per

cent

of r

espo

nden

ts

Figure 14. Basis for allocating costs to product/processes from overhead

(n=88, two answers accepted)

18%

24%27%

53% 55%

0%

10%

20%

30%

40%

50%

60%

Oth

er

Squa

re fo

otag

e of

faci

lity

spac

e

Mat

eria

l use

Prod

uctio

n vo

lum

e

Lab

or h

ours

Basis

Per

cent

of r

espo

nden

ts

figure15

Page 4

Figure 15. Sources of Cost Information When Assigning Costs to Products/Processes

(n=88, three answers accepted)

1%3% 5%

11% 13%

23%

30%

39%41%

51%

0%

10%

20%

30%

40%

50%

60%O

ther

Ven

dor e

stim

ate

Prod

. shi

pmt m

anif

.

Was

te s

hipm

t man

if.

Not

app

licab

le

Mat

eria

ls tr

acki

ng

Eng

inee

r est

imat

e

Prod

uctio

n/ o

pera

tion

logs

Purc

hasi

ng d

ata

Fin'

l acc

tng

data

Information sources

Per

cent

of r

espo

nden

ts

figure16

Page 5

Figure 16. Financial indicators used for screening projects (n=102, multiple answers accepted)

3% 3%

7%

16%

23% 23%

34%36%

0%

5%

10%

15%

20%

25%

30%

35%

40%Pr

ofita

bilit

y In

dex

Oth

er

Ret

urn

on T

otal

Ass

ests

Qua

l. E

valu

atio

non

ly

NPV IR

R

Payb

ack

RO

I

Indicator

Per

cent

of r

espo

nden

ts

figure17

Page 6

Figure 17. Financial indicators used for full project justification

None, qual. only28%

Other4%

ROTA2%

IRR18%

Payback12%

ROI24%

NPV10%

Profitability index2%

Figure 18

Page 7

Figure 18. Payback period used, payback users only (n=72)

10%

50%

32%

8%

0%

10%

20%

30%

40%

50%

60%

Lessthan 1year

1-2years

3-4years

Greaterthan 4years

Payback period

Per

cent

of r

espo

nden

ts

figure 19

Page 8

Figure 19. IRR required for approval, IRR users only (n=61)

10%

48%

25%

18%

0%

10%

20%

30%

40%

50%

60%

Lessthan10%

10-19%

20-30%

Greaterthan30%

IRR required

Per

cent

age

of r

espo

nden

ts

figure 20

Page 9

Figure 20. Time horizon for NPV, NPV users only (n=51)

47% 47%

6%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

1-5years

6-10years

Greaterthan 10

yrs

Time horizon

Per

cent

of r

espo

nden

ts

figure21

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Figure 21. IRR time horizon used, IRR users only (n=65)

48%49%

3%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

1-5years

6-10years

Greaterthan 10

yrs

Time horizon

Per

cent

of r

espo

nden

ts

figure22

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Figure 22. Approval thresholds for environmental projects compared to non-environmental projects

Higher for environmental

projects7%

Same for environmental

projects57%

Lower for environmental

projects36%

Q49-51,72,73,75data

Q49. Liability assessment method(n=50)General Electric 0%Other 10%EPA P2 Benefits 20%Internally developed 74%

Q50. Factors for which liability method accounts(n=50)Liability history waste mgmt36%Transport distance 38%Timing potential liability40%Liability history-firm 44%Perf. history-receiver 46%Compliance status--receiver52%Transport mode 58%Treatment technology 60%Waste form 76%Waste toxicity 80%Waste volume 82%

Q51. Barriers to quantifying Superfund liability(n=149)Disclosure to SEC 3%Subject to toxic torts 5%Other 7%Estimating WHEN liability will occur29%Estimating magnitude of costs45%Estimating IF liability will occur58%

Q72. Basis for allocating costs to product/processes from overhead(n=88)Other 18%Square footage of facility space24%Material use 27%Production volume 53%Labor hours 55%

Q73. Sources of cost information when assigned costs to product or process(n=88)Other 1%Vendor estimate 3%Prod. shipmt manif. 5%Waste shipmt manif. 11%Not applicable 13%Materials tracking 23%Engineer estimate 30%Production/ operation logs39%Purchasing data 41%Fin'l acctng data 51%

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Q49-51,72,73,75data

Q75. Financial indicator used in initial screening test(n=102)Profitability Index 3%Other 3%Return on Total Assests 7%Qual. Evaluation only 16%NPV 23%IRR 23%Payback 34%ROI 36%

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q79-82data

q79

Less than 1 year 10%1-2 years 50%3-4 years 32%Greater than 4 years 8%

q801-5 years 47%6-10 years 47%Greater than 10 yrs 6%

q81Less than 10% 10%10-19% 48%20-30% 25%Greater than 30% 18%

q821-5 years 48%6-10 years 49%Greater than 10 yrs 3%

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datafor4figs

Both qual. and quant 44Specific $ value 23Qualitatively only 33

not important 39very important 27somewhat important 34

Same for env. proj 57Lower for env. proj 36Higher for env. proj 7

None, qual. only 28Other 4ROTA 2IRR 18Payback 12ROI 24NPV 10Profitability index 2

100

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ENVIRONMENTAL COST ACCOUNTING FOR CAPITAL BUDGETINGinfohouse.p2ric.org/ref/03/02262.pdf · CAPITAL BUDGETING PROCESS ... Who makes initial decision to place an environmental project